Exchange Rate Economics: Theories and Evidence

Notes 403
2 Here the j superscript does not appear because we have imposed symmetry on the
identical agents within each country.
3 Where 1 + i t = (P t+1 )/(P t )(1 + r t+1 ).
4 Note also that equilibrium is characterised by a situation in which the following
transversality condition holds:
(
lim R t,t+T B t+T +1 + M )
t+T
= 0.
T →∞ P t+T
5 That is,from (10.11) we have 1 = β(1+r) and therefore there is no consumption tilting
in steady state.
6 S ′ ,the steady-state change in the exchange rate,appears here as the representation of
the expected exchange rate change in period t + 1,given the assumption that the model
gets back to steady state in one period.
7 This equation is derived by using equations (10.31),(10.39),(10.35) and (10.36) with
home and foreign government spending subtracted and using (10.49).
8 Hau (2000) introduces non-traded goods into the two-country redux model,considered
in the last section. He demonstrates that this introduction increases the size of the initial
exchange rate movement in response to a monetary shock (because non-traded prices
are tied down by the sticky nominal wage assumption,a larger exchange rate movement
is required to get a given change in the aggregate price level).
9 Therefore,we do not need to consider the production of the traded good.
11 The new open economymacroeconomic model: pricing
to market and exchange rate volatilityredux
1 This follows from substituting the assumed pricing patterns into the following industry
price index for the foreign country:
⎛
⎞
N +N ∗
1/(1−µ)
P ∗ ∑
= ⎝
1
N + N ∗ p1−µ ⎠
i
.
i=1
2 The key difference is that the term µ(η −1) is replaced with (µ−1)(η −1),because the
exchange rate is no longer exogenous and so the demand risk associated with invoicing
in the exporter’s currency has been reduced.
3 For example,in a model with a complete set of state-contingent nominal assets,complete
risk-sharing across markets implies that s t = (P t /u c,t )(u ∗ c,t /P t ).
13 The economics of fixed exchange rates, part 2: speculative
attack models and contagion
1 We follow this terminology here,although see Jeanne (2000) for a critique and an
alternative taxonomy.
2 For a variant of the first generation model with currency substitution,see Sawada and
Yotopoulos (2000).
3 As Jeanne (2000) notes,this assumption can be justified by the fact that reserve flows
move very suddenly at the time of an attack and this does not leave the authorities much
time to intervene.
4 Obstfeld (1994) provides a rigorous game-theoretic analysis of a speculative attack using
a model with two large speculators.
5 This follows from assuming that αθ 2 /(1 + α) < 1 and ruling out speculative bubbles.