The Real Exchange Rate as a Tool of Commercial Policy

Michael Mussa

No 1577, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper develops a dynamic, rational expectations model that generalizes both the standard, two-country, two-commodity model of real trade theory and the "dependent economy" model of open economy macroeconomics. This model is used to show how a variety of government policies can affect the real exchange rate (defined as the relative price of domestic goods in terms of foreign goods) and thereby replicate some of the effects of commercial policy. The policies considered include temporary and expected future shifts in the distribution of government spending, temporary general tax reductions financed by the issuance of government debt, controls on international capital movements, and policies that combine a fixed path of the nominal exchange rate and a fixed path of the nominal money supply (supported by sterilized official intervention in the foreign exchange market).

Date: 1985-03
Note: ITI IFM
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Published as Mussa, Michael. "The Effects of Commercial, Fiscal, Monetary and Exchange Rate Policies on the Real Exchange Rate,"Economic Adjustment and Exchange Rates in Developing Countries, edited by S. Edwards and Liquat Ahamed. Chicago: UCP (1986)

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