Stock Prices, Real Exchange Rates, and Optimal Capital Accumulation

International Monetary Fund

No 1988/031, IMF Working Papers from International Monetary Fund

Abstract: This paper analyzes the dynamics of the real exchange rate and the price of equity for a small open economy using an optimizing model in which the process of capital accumulation entails adjustment costs. The analysis demonstrates that along an adjustment path toward long-run equilibrium, appreciation of the real exchange rate will accompany a decline in the market price of equity, whereas depreciation of the real exchange rate will accompany a rise in the price of equity. This relationship results from the requirement that non-traded inputs are used in the investment process. In the short-run, though, the effects on these variables depend critically on whether disturbances originate in the non-traded sector and on whether disturbances are perceived as temporary or permanent. The disturbances considered include changes in fiscal policies as well as changes in the world interest rate.

Keywords: WP; capital stock; current account; interest rate (search for similar items in EconPapers)
Pages: 34
Date: 1988-01-01
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Persistent link: https://EconPapers.repec.org/RePEc:imf:imfwpa:1988/031

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