Indeterminacy and Volatility of Exchange Rates under Imperfect Currency Substitution

Mahnaz Mahdavi and Hossein B Kazemi

Economic Inquiry, 1996, vol. 34, issue 1, 168-81

Abstract: The authors know that, when currencies are perfect substitutes, exchange rates could become indeterminate. They show that, even when currencies are less than perfect substitutes, exchange rates could display volatility unrelated to economic fundamentals. With increases in currency substitution the exchange rate becomes more sensitive to changes in economic fundamentals, increasing its volatility; the exchange rate could become indeterminate and it is more likely to become so if governments pursue similar monetary policies; and currencies with high nominal interest rates would decline significantly and the exchange rate becomes more sensitive to changes in the supply of those currencies. Copyright 1996 by Oxford University Press.

Date: 1996
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