Exchange Rate Economics: Theories and Evidence

The sticky-price monetary model 131
a proportion, ρ,of the household’s initial money holdings (both home and foreign)
and uses this to buy domestic and foreign goods from other households. The third
member of the household takes the remaining proportion,1 − ρ,of the initial
money holdings and uses them to transact in asset markets. The asset markets in
this variant of the Lucas model comprise home and foreign money and home and
foreign government securities,labelled B t and Bt ∗ respectively,where the securities
are assumed to be one-period pure discount bonds.
The representative agents in the home and foreign country are assumed to
have the same intertemporal utility function,and associated properties,as given
in equation (4.19) of the previous chapter,repeated here:
( ∞
)
∑
U = E t β t U (C t , Ct ∗ ) , 0