Monetary Policy Under Exchange Rate Flexibility

Rudiger W. Dornbusch

106 citations0/0 files storedNational Bureau of Economic Research

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Monetary Policy and Economic Impact Global Financial Crisis and Policies Economic theories and models

Abstract

The paper presents an evaluation of exchange rate theories and the empirical evidence :in the field.The analysis is extended to sketch the role of flexible exchange rates :in a macroeconomic context, :in particular for the case of the U. S .Among exchange rate theories "asset-market" models are now recognized as the most attractive formulation.These models emphasize the determination of exchange rates as part of short-run asset market equilibrium.Prom:inent aIIDng these theories is the "monetary approach".A review of the evidence f:inds the empirical support for the view quite weak.An alternative approach emphasizes the imperfect substitutability of assets and views exchange rate determination as linked to the relative supplies of financial assets denom:inated :in domestic and foreign currency.EmpiriCal support for this view is only start:ing to come :in now.The paper offers a criticism of the manner :in which empirical tests of exchange rate models have been conducted.I t is shown that, along l:ines familiar from macroeconomics or f:inance, only unanticipated changes in the determinants of exchange rates should affect the deviations of exchange rates from the :interest parity trend.Such a formulation suggests that the explanatory variables are the innovations --such as unanticipated money --:in the determinants of exchange rates, not their actual levels.There is a brief review concern:ing the evidence of exchange rate effects on :inflation and trade flows.The review concludes that exchange depreciation does exert a significant effect on domestic :inflation, given the rate of unemployment, but that there do remain effects on competitiveness.Changes in real exchange rates :in turn do exert an important long-run effect on trade flows, although the lags are quite pronounced.

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References

1976Expectations and Exchange Rate Dynamics 1980Exchange Rates and the Current Account.1977A Monetary Approach To The Exchange Rate: Doctrinal Aspects And Empirical Evidence 1976A Monetary Approach to the Exchange Rate: Doctrinal Aspects and Empirical Evidence 1976A Monetary Model of Exchange Market Pressure Applied to the Post-War Canadian Experience 1978Purchasing power parity 1978The Supply and Demand for Exports: A Simultaneous Approach 1977The Exchange Rate, The Balance Of Payments and Monetary and Fiscal Policy Under A Regime of Controlled Floating

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1987A quantitative reassessment of the purchasing power parity hypothesis: Evidence from Norway and the United Kingdom 1983Floating exchange rates, expectations and new information 1980The Collapse of Purchasing Power Parities during the 1970s 1985Chapter 14 Asset markets, exchange rates and the balance of payments 1985Purchasing power parity: A quantitative reassessment of the 1920s experience

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