Solving Exchange Rate Puzzles with neither Sticky Prices nor Trade Costs
Year: 2022
Type: other
Abstract: We present a simple framework in which both the exchange rates disconnect and forward bias puzzles are simultaneously resolved. The flexible-price two-country monetary model is extended to include a consumption externality with habit persistence. Habit persistence is modeled using Campbell Cochrane preferences with „deep‟ habits. By deep habits, we mean habits defined over goods rather than countries. The model is simulated using the artificial economy methodology. It offers a neo-classical explanation of the Meese-Rogoff puzzle and mimics the failure of fundamentals to explain nominal exchange rates in a linear setting. Finally, the model naturally generates the negative slope in the standard forward market regression.
Authors: Michael J Moore, Maurice J Roche
Institutions: Queen's University Belfast, Toronto Metropolitan University
Language: English
Domain: Social Sciences
Open Access status: green
Funder: Higher Education Authority
OpenAlex ID: W4297998629