Essays on Rational Expectations and Flexible Exchange Rates

Nasser Saidi

• Publisher: Routledge
• Year: 2017
• Topic: Business
• eBook ISBN:
  9781351804837
• Subtopic: Business generale
• Index: Business

Originally published in 1982. This book deals with exchange-rate determination and the implications of floating rate regimes for the time paths of prices and quantities. It develops a class of stochastic equilibrium models of the open economy operating under flexible exchange rates, assuming that agents are endowed with rational expectations but do not possess full current information as to the state of the world. Chapters look at a model's response to economic disturbances, the effect on non-traded goods, and cyclical variations of the terms of trade. The final chapter considers a model to investigate purchasing parity issues.

Chapter V
Rational Expectations, Purchasing Power Parity and the Business Cycle

5.1 Introduction

This chapter analyzes the simultaneous determination of prices, outputs and the exchange rate in the context of a two-country model that explicitly allows for differences in prices both within and between countries. The object of the chapter is to provide an analytical framework that generates two widely observed phenomena: output fluctuations are positively correlated internationally and the existence of substantial deviations from purchasing power parity. The analytical framework embodies the following characteristics: (i) prices, the exchange rate and quantities are jointly determined in competitive equilibrium, (ii) information on the current state of each economy is imperfect; and (iii) domestic and foreign agents'expectations are endogenously determined and formed in a rational manner, a la Kuth.¹

The model developed in section 5.2 generates simultaneous fluctuations in aggregate real output in both countries and accompanying deviations from purchasing power parity due to unanticipated domestic and foreign aggregate disturbances. These real responses arise in a model in which domestic and foreign agents produce and trade in a large number of spatially and informationally distinct markets both at home and abroad. On the other hand, there is a centralized market for foreign exchange which clears every period, yielding a single exchange rate that applies for transactions in all locations. Sections 5.3, 5.4, 5.5 develop the market-clearing conditions for domestic prices, foreign prices and the exchange rate respectively, starting from the underlying demand and supply functions. Domestic and foreign prices are shown to be jointly determined a...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Original Title
• Original Copyright
• Contents
• I. INTRODUCTION AND OVERVIEW
• II. FLUCTUATING EXCHANGE RATES AND THE INTERNATIONAL TRANSMISSION OF ECONOMIC DISTURBANCES
• III. "REAL" AND NOMINAL EXCHANGE RATES IN AN UNCERTAIN WORLD: THE TRADED NON-TRADED GOODS NEXUS
• IV. CYCLICAL VARIATIONS OF THE EXCHANGE RATE AND THE TERMS OF TRADE
• V. RATIONAL EXPECTATIONS, PURCHASING POWER PARITY AND THE BUSINESS CYCLE
• BIBLIOGRAPHY
• APPENDIX