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On the Contingency of Equilibrium Exchange Rates with Time - Consistent Economic Policies

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  • Antoine Bouveret

    (OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po)

  • Bruno Ducoudre

    (OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po)

Abstract

Equilibrium exchange rate theories (FEER, BEER and NATREX) make the assumption that the Real Equilibrium Exchange Rate (RER) is independent from internal equilibrium and economic policies. We develop a model in which economic policies depend on the minimisation of an intertemporal loss function, and we show that in a Wage Setting-Price Setting (WS-PS) framework, the RER depends on the policymakers' objectives, making the previous assumptions highly questionable. We provide some results for the impact of policymakers' preferences on the long run exchange rate and discuss the concept of inflation illusion. In our model, the long run (equilibrium) exchange rate is contingent on policymakers' preferences, implying that equilibrium exchange rate estimates must be treated with great caution.

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  • Antoine Bouveret & Bruno Ducoudre, 2007. "On the Contingency of Equilibrium Exchange Rates with Time - Consistent Economic Policies," Working Papers hal-01066080, HAL.
    • Handle: RePEc:hal:wpaper:hal-01066080
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    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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