Research Discussion Papers, Bank of Finland
No 8/2006:
Exchange rate volatility without the contrivance of fundamentals and the failure of PPP
Mikael Bask ()
Abstract: Since the magnitude of exchange rate overshooting may not
be the same for different exchange rates of a currency, a monetary
expansion or contraction in, for example, the EMU, will affect the exchange
rate between the U.S. dollar and the yen, even though there are no changes
in monetary fundamentals in the U.S. or Japan. This fact is demonstrated in
a sticky-price monetary model due originally to Dornbusch (1976) that is
enlarged with currency traders that use Chartism in the form of moving
averages. It is also demonstrated that purchasing power parity (PPP) does
not necessarily hold in long-run equilibrium. The-se results are
interesting since, according to the empirical literature, there are often
large movements in nominal exchange rates that are apparently unexplained
by macroeconomic fundamentals, and there is also a weak support for PPP.
Keywords: Chartism; foreign exchange; macroeconomic fundamentals; moving averages; overshooting and PPP; (follow links to similar papers)
JEL-Codes: F31; F41; (follow links to similar papers)
21 pages, October 10, 2006
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