Exchange Rate Determination with Bank-Financed Investment

Merih Uctum and Michael Wickens

No 355, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper analyses the effects of monetary shocks in the determination of exchange rates in economies where banks play a central role in providing finance for domestic investment and in international capital transactions. This is a situation that prevails in many countries, both developed and developing. For such countries the standard models of exchange rate determination are not strictly appropriate. As there are six state variables, a rational expectations simulation model is constructed and is used to carry out the dynamic analysis. In addition to the exchange rate there are two other jump variables in the model: Tobin's q and the shadow price of bank debt, which depends on expectations of future interest rates. It is shown that financing investment through intermediation helps to stabilize the economy following a domestic monetary shock but makes the economy more vulnerable to a foreign monetary shock.

Keywords: Bank Finance; Capital Controls; Exchange Rates (search for similar items in EconPapers)
Date: 1989-11
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Working Paper: EXCHANGE RATE DETERMINATION WITH BANK FINANCED INVESTMENT (1989)
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