Lecture 6 animated 2019-20 post.pptx - Lecture 6 Short-run asset approach exchange rate model and Fixed Exchange Rate Short-run asset approach to

# Lecture 6 animated 2019-20 post.pptx - Lecture 6 Short-run...

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Lecture 6 Short-run asset approach exchange rate model and Fixed Exchange Rate

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Short-run asset approach to exchange rate Output Y is fixed Price level P is sticky Nominal (E) and real exchange rates (q) are proportional to each other, % E = % q Nominal (i) and real interest rate (r) are equal Nominal interest rate is flexible in the short run and can deviate from its long-run level to clear the money market
Short-run asset approach to exchange rate Exogenous variables : M, M*, P, P*, Y, Y*, E e , where E e = long-run equilibrium exchange rate Endogenous variables : i, i*, E Model (1) = L( i ) Y i = f ( M, P, Y ) MM Equil (2) = L( i* ) Y* i* = f ( M*, P*, Y* ) MM Equil (3) i = i* + FXM Equil

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Money Market Equilibrium In the short-run it is the nominal interest rate, instead of the price level, that clears the money market. MM equil is achieved as consumers switch between money and bond to achieve their desired money holding
Short-run FX Market Equilibrium i = i* +

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Applying the short-run exchange rate model Let us consider how the exchange rate adjusts to various shocks to the fundamentals Temporary shock : No effect on the long run equilibrium exchange rate and E e

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