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Nominal exchange rate determination and dynamics in an OLG framework

Mauro Bambi () and Sara Eugeni ()
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Mauro Bambi: Durham University
Sara Eugeni: Durham University

Economic Theory, 2021, vol. 72, issue 1, No 4, 93-132

Abstract: Abstract The empirical evidence on nominal exchange rate dynamics shows a long-run relationship of this variable with the fundamentals of the economy, although such relationship disappears at shorter horizons. This apparently contrasting behaviour of the nominal exchange rate can be explained in an overlapping generations model where the currencies are not perfect substitutes. In this framework, we show that the nominal exchange rate is pinned down by the fundamentals at the monetary steady state. We study the local dynamics and show that when the monetary steady state is locally indeterminate, then fluctuations of the nominal exchange rate around its long-run value can emerge. In particular, we prove the existence of stationary sunspot equilibria, where random fluctuations of the nominal exchange rate arise as a result of self-fulfilling beliefs.

Keywords: Nominal exchange rate determination; Nominal exchange Rate dynamics; OLG models; Sunspot equilibria (search for similar items in EconPapers)
JEL-codes: F31 F41 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1007/s00199-020-01271-3

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