Welfare and Excess Volatility of Exchange Rates

Quaderni DSE Working Paper No. 758

34 Pages Posted: 11 Jun 2011

See all articles by Matteo Salto

Matteo Salto

Directorate-General COMP, European Commission

Tito Pietra

University of Bologna - Department of Economics

Date Written: June 10, 2011

Abstract

We study the properties of a GEI model with nominal assets, outside money (injected into the economy as in Magill and Quinzii), and multiple currencies. We analyze the existence of monetary equilibria and the structure of the equilibrium set under two different assumptions on the determination of the exchange rates. If currencies are perfect substitutes, equilibrium allocations are indeterminate and, generically, sunspot equilibria exist. Generically, given a nonsunspot equilibrium, there are Pareto improving (and Pareto worsening) sunspot equilibria associated with an increase in the volatility of the future exchange rates. We interpret this property as showing that, in general, there is no clear-cut effect on welfare of the excess volatility of exchange rates, even when due to purely extrinsic phenomena.

Keywords: Incomplete markets, exchange rates, real indeterminacy, sunspots, Pareto efficiency

JEL Classification: D52

Suggested Citation

Salto, Matteo and Pietra, Tito, Welfare and Excess Volatility of Exchange Rates (June 10, 2011). Quaderni DSE Working Paper No. 758, Available at SSRN: https://ssrn.com/abstract=1861205 or http://dx.doi.org/10.2139/ssrn.1861205

Matteo Salto (Contact Author)

Directorate-General COMP, European Commission ( email )

Rue de la Loi 200
Brussels, B-1049
Belgium

Tito Pietra

University of Bologna - Department of Economics ( email )

Strada Maggiore 45
Bologna, 40125
Italy

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