Contract length, monetary policy and exchange rate variability

This paper investigates the dependence of exchange rate variability on average contract length in the goods market when changes in the money supply are the driving force for movements in the exchange rate. It is shown that, in general, an increase in average contract length will increase the volatility of the exchange rate. We then discuss how changes in the money supply process affect average contract length. Besides providing an explanation for changes in the conditional variance of the exchange rate our results are interesting in the light of the changes in Monetary Control Procedures implemented by the Federal Reserve Board in October 1979 and the consequent increase in exchange rate volatility.