Abstract:
In the political discussion, exchange rates are often said to be overvalued or undervalued. This is due to the fact that exchange rates have to fulfill a (more than) dual role: they have to balance international goods markets and international capital markets. In general, economic models try to handle this problem by introducing short-term overshooting effects of the exchange rate induced by monetary disturbances. Yet, especially in estimating these models, a fixed relationship between asset markets and goods markets is assumed: the adjustment speed of the actual overshooting exchange rate to its long-run level is kept constant over time. In this paper, we introduce a time-varying index for capital market integration via expectation formation in the context of a monetary approach to the exchange rate with sticky prices.