Abstract
This paper analyzes exchange-rate dynamics in a model that integrates slowly-adjusting prices with wealth accumulation dynamics under imperfect asset substitutability. The aim is to examine the overshooting hypothesis and the nature of the dynamic path following a change in monetary policy. The model incorporates sluggish adjustment of trade flows to relative prices, and the interaction of wealth accumulation with the government budget constraint, and assumes rational expectations in the assets markets and adaptive expectations in the labor market. It shows that the nature of the exchange-rate dynamic path depends on the speed of adjustment of the labor market. Copyright 1989 by Royal Economic Society.
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