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INDETERMINACY AND VOLATILITY OF EXCHANGE RATES UNDER IMPERFECT CURRENCY SUBSTITUTION
Author(s) -
Mahdavi Mahnaz,
Kazemi Hossein B.
Publication year - 1996
Publication title -
economic inquiry
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.823
H-Index - 72
eISSN - 1465-7295
pISSN - 0095-2583
DOI - 10.1111/j.1465-7295.1996.tb01370.x
Subject(s) - economics , monetary economics , imperfect , volatility (finance) , currency , currency substitution , exchange rate , indeterminate , econometrics , foreign exchange risk , linguistics , philosophy , mathematics , pure mathematics
We know that when currencies are perfect substitutes, exchange rates could become indeterminate. We show that even when currencies are less than perfect substitutes exchange rates could display volatility unrelated to economic fundamentals. With increases in currency substitution: (1) the exchange rate becomes more sensitive to changes in economic fundamentals, increasing its volatility; (2) the exchange rate could become indeterminate, and it is more likely to become so if governments pursue similar monetary policies; (3) currencies with high nominal interest rates would decline significantly and the exchange rate becomes more sensitive to changes in the supply of those currencies.