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The most important insight of the model is that adjustment lags in some parts of the economy can induce compensating volatility in others; specifically, when an exogenous variable changes, the short-term effect on the exchange rate can be greater than the long-run effect, so in the short term, the exchange rate overshoots its new equilibrium ...
This model can account for real exchange rate volatility, but does not say anything about the volatility of relative to output or the persistence of the real exchange rate movements. Chari , Kehoe and McGrattan (2002) [ 2 ] showed how a model with two countries and where prices were only allowed to change once-a-year had the potential to ...
In foreign exchange, a relevant factor would be the rate of change of the foreign currency spot exchange rate. A variance, or spread, in exchange rates indicates enhanced risk, whereas standard deviation represents exchange-rate risk by the amount exchange rates deviate, on average, from the mean exchange rate in a probabilistic distribution. A ...
2. Interest rates. Interest rates play a major role in a currency’s value and are an essential part of a country’s monetary policy. Governments often adjust interest rates to manage inflation ...
Here’s how exchange rates are determined: Supply and demand in the global foreign exchange market—where traders buy and sell currencies based on several economic factors—decide exchange ...
The main idea is that large exchange rate volatility may lead to inflation volatility, which reduces the credibility of monetary policymakers for inflation targeting. This high inflation volatility is very costly due to higher risk premia, hedging costs and unforeseen redistribution of wealth .
In a floating exchange rate system, a currency's value goes up (or down) if the demand for it goes up more (or less) than the supply does. In the short run this can happen unpredictably for a variety of reasons, including the balance of trade, speculation, or other factors in the international capital market. For example, a surge in purchases ...
The monetary union eliminates the time inconsistency problem within the zone and reduces real exchange rate volatility by requiring multinational agreement on exchange rate and other monetary changes. The potential drawbacks are that member countries suffering asymmetric shocks lose a stabilization tool—the ability to adjust exchange rates.