Exchange rate indeterminacy in portfolio balance, Mundell-Fleming and uncovered interest rate parity models

With full stock/flow accounting respected, the two-country openeconomy portfolio balance model has just two independent equationsfor asset market clearing. It can determine home and foreigninterest rates but not the exchange rate. If asset market equilibriavary smoothly over time, the balance of payments equation inthe Mundell–Fleming model is not independent and cannotset the exchange rate either. The familiar fixed reserves/‘floatingrate’ vs endogenous reserves/‘fixed rate’dichotomy does not exist, and ‘fundamentals-based’econometric models of the exchange rate are bound to fail. Analternative is a two-country IS/LM model with exchange ratedynamics added. Its dynamic properties under uncovered interestrate parity are briefly explored.