Working Paper

Real exchange rate dynamics revisited: a case with financial market imperfections

Abstract: In this paper, we investigate the relationship between real exchange rate dynamics and financial market imperfections. For this purpose, we first construct a New Open Economy Macroeconomics (NOEM) model that incorporates staggered loan contracts as a simple form of the financial market imperfections. Our model with such a financial market friction replicates persistent, volatile, and realistic hump-shaped responses of real exchange rates, which have been thought very difficult to materialize in standard NOEM models. Remarkably, these realistic responses can materialize even with both supply and demand shocks, such as cost-push, loan rate and monetary policy shocks. This implies that the financial market developments is a key element for understanding real exchange rate dynamics.

JEL Classification: F31; F41;

Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Globalization Institute Working Papers

Publication Date: 2010

Number: 62

Pages: 48 pages

Note: Published as: Fujiwara, Ippei and Yuki Teranishi (2011), "Real Exchange Rate Dynamics Revisited: A Case with Financial Market Imperfections," Journal of International Money and Finance 30 (7): 1562-1589.