Business Intelligence

Money, Capital And Exchange Rate Fluctuations

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Executive Summary

The authors explore how the informational frictions underlying monetary exchange affect international exchange rate dynamics. Using a two-country, two-sector model, they show that information frictions imply a particular restriction on domestic price dynamics and hence on international nominal and real exchange rate determination. Furthermore, if capital is utilized as a factor of production in both production sectors, then there is a further restriction on asset pricing relations (money and capital). As a result, monetary and real outcomes become interdependent in the model. Their perfectly flexible price model is capable of producing endogenously rigid international relative prices in response to technology and monetary shocks.

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