International Liquidity and Exchange Rate Dynamics *

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ID: 307220
2015
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Abstract
Abstract We provide a theory of the determination of exchange rates based on capital flows in imperfect financial markets. Capital flows drive exchange rates by altering the balance sheets of financiers that bear the risks resulting from international imbalances in the demand for financial assets. Such alterations to their balance sheets cause financiers to change their required compensation for holding currency risk, thus affecting both the level and volatility of exchange rates. Our theory of exchange rate determination in imperfect financial markets not only helps rationalize the empirical disconnect between exchange rates and traditional macroeconomic fundamentals, it also has real consequences for output and risk sharing. Exchange rates are sensitive to imbalances in financial markets and seldom perform the shock absorption role that is central to traditional theoretical macroeconomic analysis. Our framework is flexible; it accommodates a number of important modeling features within an imperfect financial market model, such as nontradables, production, money, sticky prices or wages, various forms of international pricing-to-market, and unemployment.
Reference Key
openalex_W2257520161 Use this key to autocite in the manuscript while using SciMatic Manuscript Manager or Thesis Manager
Authors Xavier Gabaix, Matteo Maggiori
Journal the quarterly journal of economics
Year 2015
DOI
10.1093/qje/qjv016
URL
https://doi.org/10.1093/qje/qjv016
Keywords Keywords not found

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