Exchange Rate Economics: Theories and Evidence

100 The flexible price monetary approach
how,in contrast to the sticky-price model,real exchange rate changes are driven
by real shocks rather than the interaction of exchange rate overshooting and sticky
prices. We now consider this variant of the flex-price model.
The Lucas model is essentially a barter economy model into which money is
introduced through a cash-in-advance constraint. We therefore first consider the
barter version of the model before going on to consider the introduction of a cashin-advance
constraint into the model. The barter economy aspects are considered
in Section 4.3.1 and money is introduced into this barter set-up in Section 4.3.1.1.
4.3.1 The Lucas barter economy
The model comprises two countries,each country producing a single good and
where the representative agent in each country has an intertemporal utility function
given by:
( ∞
)
∑
U = E t β t U (C t , Ct ∗ ) , 0