Solving exchange rate puzzles with neither sticky prices nor trade costs

Michael J. Moore, Maurice J. Roche

Research output: Contribution to journalArticlepeer-review

16 Citations (Scopus)

Abstract

We present a simple framework in which both the exchange rate disconnect and forward bias puzzles are simultaneously resolved. The flexible-price two-country monetary model is extended to include a consumption externality with habit persistence. Habitpersistence is modeled using Campbell Cochrane preferences with ‘deep’ habits along the lines of the work of Ravn, Schmitt-Grohe and Uribe. By deep habits, we mean habits defined over goods rather than countries. The model is simulated using the artificial economy methodology. It offers a neo-classical explanation of the Meese–Rogoff puzzle and mimics the failure of fundamentals to explain nominal exchange rates in a linear setting. Finally, the model naturally generates the negative slope in the standard forward market regression.
Original languageEnglish
Pages (from-to)1151-1170
Number of pages20
JournalJournal of International Money and Finance
Volume29
Issue number6
DOIs
Publication statusPublished - Oct 2010

ASJC Scopus subject areas

  • Economics and Econometrics
  • Finance

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