A Behavioral New Keynesian Model of a Small Open Economy Under Limited Foresight
Seunghoon Na and
Staff Working Papers from Bank of Canada
This paper investigates exchange rate dynamics in open economies by incorporating bounded rationality. We develop a small open-economy New Keynesian model with an incomplete asset market, wherein decision-makers possess limited foresight and can plan for only a finite distance into the future. The equilibrium dynamics depend on the degree of foresight and the decision-makers’ belief-updating behaviors that approximate continuation values at the end of their planning horizons. This limited foresight leads to persistent, non-monotonic forecast errors in the real exchange rate across time horizons and distinguishes between short- and long-term expectations. This framework hence provides a micro-foundation for understanding time-horizon variability in uncovered interest parity puzzles.
Keywords: Exchange rates; Monetary policy transmission; International topics; Business fluctuations and cycles (search for similar items in EconPapers)
JEL-codes: E43 E70 F31 F41 (search for similar items in EconPapers)
Pages: 70 pages
New Economics Papers: this item is included in nep-cba, nep-dge and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:23-44
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