Exchange Rate Volatility: The Role of Real Shocks and the Velocity of Money

Kevin Salyer ()

Economic Inquiry, 1989, vol. 27, issue 3, 387-409

Abstract: The effects of stochastic output shocks on the behavior of exchange rates and nominal price levels is studied within the context of a two-country, cash-in-advance model. The analysis of this model, in contrast to the existing cash-in-advance literature, demonstrates that exchange rates can be more volatile than price levels even though agents' elasticity of substitution between foreign and domestic goods is greater than one-half. This possibility arises when output shocks are autocorrelated and are due to revisions in expectations that affect the terms of trade and/or the velocity of money. Copyright 1989 by Oxford University Press.

Date: 1989
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