The Economics of Exchange Rates (Collected Works of Harry Johnson)

CHAPTER 2

THE THEORY OF FLEXIBLE EXCHANGE RATE REGIMES AND MACROECONOMIC POLICY

RUDIGER DORNBUSCH

Massachusetts Institute of Technology,Cambridge, Mass., USA

ABSTRACT

This paper develops three perspectives on the determination of exchange rates and their interaction with macroeconomic equilibrium and aggregate policies. A long-run view characterizes exchange rate determination in terms of monetary and real factors where the real aspects include an explicit consideration of relative price structures. A short-run or “liquidity” view of the exchange rate emphasizes the role of asset market equilibrium and expectations. A policy view, finally, analyzes the effectiveness of aggregate policies and points out that in the short-run nominal disturbances ...