The interplay between real and exchange rate market: an agent-based model approach

We present a multi-country, multi-sector agent-based model that extends Dosi et al. (2019) and incorporates the exchange market and its interaction with the real economy. The exchange rate is influenced not only by trade flows but also by the heterogeneous demand for foreign currencies from financial traders. In this respect, the dual nature of the exchange rate is highlighted, acting both as a transmission channel of endogenous shocks and as a source of shocks. Indeed, differing beliefs bring about real-financial non-linear patterns with feedback mechanisms. Simulations show that the introduction of speculative sentiment behaviour reflects important stylised facts of bilateral exchange rate series. Furthermore, the findings indicate that trend-following behaviour substantially increases financial turbulence and contributes to real economic fluctuations. Finally, we highlight the power and limitations of the central bank as an actor in the exchange rate market, showing that while the central bank's interventions can effectively curb boom-bust cycles, their outcomes differ substantially.