A BEHAVIOURAL FINANCE MODEL OF EXCHANGE RATE EXPECTATIONS WITHIN A STOCK-FLOW CONSISTENT FRAMEWORK

Abstract

The paper combines behavioural finance to a stock-flow consistent model of a two-country economy in the portfolio tradition, with imperfect asset substitutability. ‘Conventionalists’ and ‘chartists’ set their expectations of changes in exchange rates based on some assessed fundamental value and past trends, respectively. We find that exchange rate expectations have a significant effect on exchange rate movements and trade account balances during the traverse and in steady states. A flexible exchange rate regime will continue to provide stabilizing properties, as long as the proportion of chartist actors relative to other agents is not overly large.

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