Monetary Expansion and Real Exchange Rate Dynamics

Abstract

This paper examines the effect of a change in the rate of monetary expansion on the dynamics of the real exchange rate under fully flexible domestic prices and a floating exchange rate. The model is similar in structure to an ealier paper by Calvo and Rodríguez, the main difference being that in our model consumers have an infinite planning horizon and long-run perfect foresight. One of the main findings is that an increase in the rate of monetary expansion has the impact effect of creating a real appreciation of the exchange rate and a deterioration of the balance of payments, contrary to the results of Calvo and Rodríguez.