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Exchange rates, sunspots and cycles.

Bambi, Mauro and Eugeni, Sara (2018) 'Exchange rates, sunspots and cycles.', Working Paper. Durham University Business School, Durham .

Abstract

The empirical evidence on nominal exchange rate dynamics shows a long-run relationship of this variable with the fundamentals of the economy, although such relationship disappears at shorter horizons (“exchange rate disconnect” puzzle). This apparently contrasting behaviour of the nominal exchange rate can be explained in an overlapping-generations model where the two currencies are not perfect substitutes. In this framework, we show that the nominal exchange rate is pinned down by the fundamentals of the economy at the monetary steady state. However, fluctuations of the nominal exchange rate around its long-run value, which are not driven by shocks to fundamentals, can emerge. Firstly, we prove the existence of endogenous (deterministic) business cycles in the nominal exchange rate. Secondly, we construct stationary sunspot equilibria where random fluctuations of the nominal exchange rate arise as a result of self-fulfilling beliefs.

Item Type:Monograph (Working Paper)
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Status:Peer-reviewed
Publisher Web site:https://www.dur.ac.uk/business/research/economics/working-papers/
Date accepted:No date available
Date deposited:23 May 2019
Date of first online publication:2018
Date first made open access:No date available

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