Abstract
This paper incorporates the Holmes and Smyth (1972) specification, that is, the transactions demand for money should depend on consumer expenditure rather than national income, into the Dornbusch (1976) model. Based on such an amended model, we focus on how exchange rates adjust over time following an anticipated permanent increase in government spending. It is found that whether the domestic currency will depreciate or appreciate following a balanced-budget fiscal expansion is sensitive to plausible specification in the money demand function. In addition, it is also found that the misadjustment pattern of exchange rate can be observed in response to a balanced fiscal expansion, even if the system displays the saddlepoint stability rather than the global instability proposed by Aoki (1985).
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