Predicting Changes in Exchange Rates Based on the MBOP
In This Chapter
Working with the combined MBOP model
Understanding the difference between real and nominal shocks
Predicting short- and long-run implications of nominal shocks
Providing an explanation of exchange rate volatility through overshooting
This chapter uses the MBOP (the Monetary Approach to Balance of Payments introduced in Chapter 6) to predict the changes in exchange rates. You will see that there are real and nominal variables in the MBOP whose changes affect exchange rates. Real variables have no price effect in them. Real GDP is an example for a real variable, because it is adjusted for the changes in inflation. A nominal variable has price effect in it and therefore you’ll see that a change in the nominal money supply affects exchange rates. Additionally, in terms of a change in a nominal variable such as the nominal money supply, I discuss how to make both short-and long-run predictions regarding the change in the exchange rate.
Applying Real Shocks to MBOP
The section starts with real shocks, because ...