A Graphical Analyzing the Honeymoon Effect of Exchage Rate Target Zones with Uncertain Policy in an Open Economy?An Example of Disturbances in Aggregate Supply

Peir-Shyan Liaw () and Yu-Shin Shen
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Peir-Shyan Liaw: Economic Department, Tunghai University, Taiwan
Yu-Shin Shen: Graduate Institute of Economics, Tunghai University, Taiwan

Journal of Economics and Management, 2010, vol. 6, issue 1, 33-77

Abstract: This paper extends the theoretical framework of Frenkel and Rodriguez (1982); Sutherland (1995) model to policy uncertainty case. In a stoachastic open macroeconomic model is characterized by purchasing power parity postulate doesn't hold and imperfect capital mobility, we use the Lai and Chang's (2001) "new graphical approach" to interprate if a country is faced with stoachastic disturbance of aggregate supply and the monetary authority adopts the "exchange rate target zones" policy, what will be the effect of these disturbances on the possible honeymoon effect of relevant macroeconomic variables? The major findings are: (1) The capital mobility degree is the key factor to determine wherther the relevant macroeconomic variables have the honeymoon effect and explain the positive empirical relationships between the exchange rate and interests rate which was observed by Kempa and Nelles (1999) or not? (2) If the monetary authority perhaps maintains the target zone policy or realigns the central parity of exchange rate, the local people are faced with this uncertain policy, the relative magnitude of capital mobility degree and the probability of local people expect the monetary authority will realign the central parity of exchange rate are the key factors to determine whether the relevant macroeconomic variables own the honeymoon effect and explain the positive empirical relationships between the exchange rate and interests rate which was observed by Kempa and Nelles (1999) or not?

Keywords: exchange rate target zone; honeymoon effect; Browian motion; realignment; the relative magnitude of capital mobility degree (search for similar items in EconPapers)
JEL-codes: F41 (search for similar items in EconPapers)
Date: 2010
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