A Model of Trade and Exchange Rate Projections

Abstract

This paper develops and applies a model of world trade and exchange rates to analyze dynamic interaction of the current account and exchange rate. The model is designed to concentrate on the determination of trade flows, prices and exchange rates for the OECD member countries but it also covers oil exporting countries, other developing countries and Centrally Planned Economies. The model contains exchange rate equations, based on the asset market approach, for major OECI) countries and adjustable pegging rules for small OECD countries and for non-oil LDOs. These provide the link from asset accumulation through the current account to the exchange rate. With the integration of exchange rate equations into the trade model, it can be used to analyze outcomes of different exchange rate regimes and alternative growth prospects in the OECD area. Simulation results indicate that the model produces a smooth and slow adjustment process for exchange rates and current accounts. They also show that with the higher growth target for an individual country large current account deficits may occur or large changes in real exchange rates are needed to reach the external equilibrium.