Exchange Rate Economics: Theories and Evidence

260 The new open economy macroeconomics part 1
and
( ) −n
´F = ´F ∗ =ŷ ∗ − Ĉ ∗ + nŜ,(10.36)
1 − n
where we have used (10.3a ′′ ) and (10.3b ′′ ) and the fact that p(h) and p ∗ (f ) are
preset. It is worth noting that steady-state values of F appear in (10.35) and (10.36).
This is because with one-period price setting,whatever net foreign asset stocks arise
at the end of the first period become the new steady-state values from period 2
onwards.
The implications of an unanticipated monetary shock may be seen by substituting
(10.33) into (10.32),using (10.31) and noting that Ḿ − Ḿ ∗ = ˆM − ˆM ∗
(because the money supply shock is permanent):
Ŝ = ˆM − ˆM ∗ − 1 (Ĉ − Ĉ ∗) . (10.37)
ɛ
Comparing (10.37) with (10.33) it must follow that the exchange rate moves immediately
to its new long-run value – there is no exchange rate overshooting. The
intuition for this is quite simple – if agents expect that the consumption differential
is constant (as in (10.31)) and that the money differential is also constant then a
constant exchange rate must also be expected.
10.1.5 Agraphical portrayal of the NOEM model
A graphical portrayal of the effect of an unanticipated increase in the money
supply is presented in Figure 10.1. The MM schedule represents equation (10.37)
and captures the equilibrium relationship between home–foreign consumption and
%∆S
G
^
M
^
M – M*
Slope = –1 ε
Slope =
δ(1 + θ)+2θ
δ(θ 2 – 1)
M
G
^ ^
%∆(C – C*)
Figure 10.1 Short-run equilibrium in NOEM.