The Exchange Rate and its Fundamentals. A Chaotic Perspective

41 Pages Posted: 31 Jan 2002

See all articles by Paul De Grauwe

Paul De Grauwe

London School of Economics & Political Science (LSE); CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Centre for Economic Policy Research (CEPR)

Marianna Grimaldi

Monetary Policy Division Sveriges Riksbank

Date Written: January 2002

Abstract

We analyse the workings of a simple non-linear exchange rate model in which agents hold different beliefs about the underlying model. We distinguish between "chartists" and "fundamentalists". The non-linearities in the model originate from transactions costs and from the existence of non-linear adjustment dynamics in the goods market. We find, first, that the simple non-linear structure of the model is capable of generating a very complex exchange rate dynamics. Second, our model is capable of explaining some empirical puzzles concerning exchange rate behaviour, i.e. the "disconnect" puzzle which says that the exchange rate is disconnected form its underlying fundamentals most of the time and the excess volatility puzzle.

JEL Classification: F31, F37

Suggested Citation

De Grauwe, Paul and Grimaldi, Marianna, The Exchange Rate and its Fundamentals. A Chaotic Perspective (January 2002). CESifo Working Paper Series No. 639. Available at SSRN: https://ssrn.com/abstract=298168

Paul De Grauwe (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Marianna Grimaldi

Monetary Policy Division Sveriges Riksbank ( email )

S-103 37 Stockholm
Sweden

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