Trade flow lags, monetary and fiscal policy, and exchange-rate overshooting |
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Authors: | Jay H Levin |
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Institution: | 1. Faculty of Economics, University of Cambridge, Austin Robinson Building, Sidgwick Avenue, Cambridge CB3 0EE, United Kingdom;2. School of Economics, Nanjing University, 22 Hankou Road, Nanjing, Jiangsu 210093, China;3. CRPE and School of Economics, Zhejiang University, 38 Zheda Road, Hangzhou, Zhejiang 310028, China |
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Abstract: | In this paper model a is constructed that combines trade slow lags with the model in the appendix to Dornbusch's seminal paper on exchange-rate dynamics. Here output is free to vary and inflation is determined by a simple Phillips curve mechanism. It turns out that, because of the trade slow lags, monetary expansion causes interest rates to decline, but the exchange rate need not oveshoot, as one would expect; whereas fiscal policy always produces overshooting. It follows that monetary policy may be a less important source of exchange-rate variability than is commonly believed, and fiscal policy more important. |
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