Strategies for Modeling Exchange Rates and Capital Flows in Multi-Country Macroeconomic Models

Abstract

The paper surveys exchange rate models, but in a way that differs from existing surveys because it focusses on alternatives available for inclusion in structural multi-country models. It emphasizes that non-structural time-series models or reduced forms are not useful in this context: what is needed are structural models that are theoretically consistent with the rest of the model, whether or not they outperform a random walk. Alternative exchange rate and capital flow specifications that are both tractable and satisfy world adding-up constraints are proposed, and the modeling of expectations is discussed.

JEL Classification: 2120, 4314