Exchange rate expectations and monetary policy

The adjustment process to a monetary disturbance is studied in a model of perfect capital mobility and flexible exchange rates. Exchange rate expectations are emphasized and used to establish an adjustment process. In the short run, a monetary expansion gives rise to a depreciation in the exchange rate and a reduction in saving due to the terms of trade deterioration. The exchange rate depreciation, in the short run, may be in excess of the long-run depreciation. The trade balance in the short run may worsen. The long-run equilibrium of the analysis conforms to the Mundell-Fleming results that establish the force of monetary policy under flexible rates.