Monetary Restraint and the Exchange Rate
Bibliographic Data
| ID | 9727027 |
|---|---|
| Authors | Patrick Honohan (0000-0003-2095-1375, corresponding author) |
| Year | 1984 |
| Volume | 51 |
| Issue | 202 |
| Pages | 163 |
| Publication date | 1984-05-01 |
| Peer Reviewed | Yes |
| Open Access | No |
| Type | ARTICLE |
| Venue | Economica (JOURNAL) |
| Journal identifiers | ISSN: 0013-0427 • E-ISSN: 1468-0335 |
| Publisher | JSTOR (PUBLISHER) |
| DOI | 10.2307/2554208 |
| OpenAlex | W1994153531 |
| Language | EN |
| References cited | 4 |
This paper examines the short-run response of the exchange rate and the level of interest rates to an unanticipated change in monetary policy.l In particular, a sudden reduction in the rate of monetary expansion is postulated in an economy with a floating exchange rate. Will the exchange rate overshoot its long-run path, as in the case of a discrete change in the nominal money stock? Will interest rates, traditional indicators of monetary conditions, rise in response to this move towards monetary restraint? Despite a growing literature on the determination of exchange rates, and a general acceptance of the key role of monetary policy in influencing the foreign exchange market, this particular question has not received much attention.' This is probably because authors have preferred to examine the normative question of optimal exchange market intervention policy.2 In Section I we take the simplest case, where the exchange rate is determined by the actions of speculators with perfect foresight, or equivalently of riskneutral speculators with rational expectations. The long-run or steady-state path-where all prices adjust instantaneously-is contrasted with the .exchange rate consistent with subject to the slow adjustment of some domestic prices. We show that this latter path, which will be referred to as the momentary path (or, where there is no risk of confusion, simply as the equilibrium path), need not overshoot the steady-state path. Nevertheless, the nominal interest rate will always fall in this case. In Section II we show that risk aversion on the part of speculators is likely to reduce the incidence of overshooting, and should moderate the tendency of the interest rate to fall.3 Although they are still allowed myopically rational expectations, speculators in Section III make transitory errors in forecasting the long-run equilibrium. This behaviour can lead to the intuitively plausible pattern of an initial increase in nominal interest rates and a gradual rather than sudden response of the exchange rate. This discussion of a variety of models allows an interplay between theory and practical experience. On the one hand, doubt is cast on the realism of certain models which give implausible results, while on the other hand, models that pass the test of plausibility provide an insight into the forces governing the reaction of financial market variables to policy change
Economics · Exchange rate · Monetary economics · Economic theories and models · Economic Theory and Policy · Monetary Policy and Economic Impact
| Citation velocity | historical |
|---|---|
| Highly cited | No |