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Abstract

This paper contributes to the literature through developing a model of exchange rate adjustments in a dynamic IS-LM-X analytical framework. Our new model, in particular, a) makes the IS-LM model dynamic; b) endogenizes the exchange rate and price variables and; c) extends the dynamic IS and LM components into the external sector in an open economy that evolves over time. The effect of a change in monetary policy on the exchange rate is evaluated and the trajectory towards its new long-run equilibrium level is projected. These are in contrast to the traditional monetary models of exchange rate determination and adjustments that play primarily with the LM component of the IS-LM framework in discrete steps. Effects of interest rate parity and purchasing power parity are then scrutinized, ranging from the short-term to the long-run continuously. The study has profound policy implications, especially in an era of quantitative easing.

DOI

10.1016/j.inteco.2016.12.001

Publication Date

2017-05-01

Publication Title

International Economics

Volume

149

ISSN

2110-7017

Embargo Period

2018-06-10

Organisational Unit

Plymouth Business School

First Page

74

Last Page

86

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