Third-Country Effects of the U.S. Poloicies on the Relative Real Exchange Rates in the G-7 Countries

This paper provides a three-country exchange rate model to explore ways in which a country (especially the United States)'s domestic shocks influence the third-countries' exchange rates. Using the same framework, a traditional proposition concerning the exchange rate and capital flovvs is examined in the three-country ver-sion. Our study indicates that the third-country effects of the U.S. policies on the relative exchange rates are not trivial, depending on the source of disturbances, eco-nomic conditions and the world excess demand elasticities of goods for each country in multilateral world. It is also shown that a traditional relationship between the exchange rate and capital flows would hold even in the three-country version under the large-country assumption. An evidence using quarterly data for the G-7 countries over the period 1978 Q1 to 1993 Q2 generally supports the model.