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Title:Stabilizing rational speculation and price level targeting PDF Logo
Authors:Reither, Franco
Bennöhr, Lars
Issue Date:2010
Series/Report no.:Diskussionspapier, Helmut-Schmidt-Universität, Fächergruppe Volkswirtschaftslehre 104
Abstract:We analyze the contribution of speculation to exchange rate volatility using different assumptions regarding speculation strategies and monetary policy rules. We take the DORNBUSCH (1976) model as the starting point and adopt a slight modification of the money demand specification. With a money supply rule, rational speculation dampens the overshooting of the exchange rate following a money supply shock, compared with speculation based on static expectations. Then, we replace the LM condition by a TAYLORtype price level targeting rule rule. The resulting 'DORNBUSCH-TAYLOR' model generates a unique saddle point solution even under 'strict' inflation targeting, if speculation is based on rational expectations. Under 'flexible' inflation targeting, exchange rate overshooting induced by a monetary policy shock is less pronounced under rational speculation than under static speculation. FOREX market equilibrium doesn't exist at all if speculation is static and monetary policy adopts'strict' inflation targeting.
Subjects:Fair rational expectations
open economy macroeconomics
Persistent Identifier of the first edition:urn:nbn:de:gbv:705-opus-26293
Document Type:Working Paper
Appears in Collections:Diskussionspapiere, Fächergruppe VWL, Helmut-Schmidt-Universität

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