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The Exchange Rate-Investment Nexus and Exchange Rate Instability: Another Reason for ‘Fear of Floating’

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Author Info
Habib Ahmed () (Institute of Middle Eastern and Islamic Studies, Durham University)
C. Paul Hallwood () (Department of Economics, University of Connecticut)
Stephen M. Miller () (Department of Economics, University of Nevada, Las Vegas)

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Abstract

We show that expansionary monetary policy causes exchange rate overshooting due to the secondary repercussion comes through the reaction of firms to changed asset prices and the firms’ decisions to invest in real capital. This overshooting effect adds to any overshooting that occurs through the traditional Dornbusch (1976) channel, since our model with its market clearing in the short run excludes any Dornbusch overshooting. The model sheds further light on the volatility of real and nominal exchange rates. It suggests that changes in corporate sector profitability may affect exchange rates through international portfolio diversification in corporate securities, and it offers an additional reason for ‘fear of floating’.

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File URL: http://www.unlv.edu/projects/RePEc/pdf/0918.pdf
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Publisher Info
Paper provided by University of Nevada, Las Vegas , Department of Economics in its series Working Papers with number 0918.

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Length: 48 pages
Date of creation: Mar 2009
Date of revision:
Publication status: forthcoming in Keio Economic Studies
Handle: RePEc:nlv:wpaper:0918

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Related research
Keywords: exchange rates; open economy macroeconomics; monetary policy; exchange rate overshooting;

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Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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