Exchange Rates, Asset Markets, and Monetary Policy

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ABSTRACTProp ID: SES-0451671 P I: Engel, Charles Organization: University of Wisconsin-Madison Title: Exchange Rates, Asset Markets, and Monetary Policy The first part of the project description proposes building an open-economy general equilibrium model that incorporates some important features that are consistent with empirical evidence on international pricing behavior, and investigating the implications for monetary policy. Specifically, the model will incorporate the low pass-through of exchange rates to consumer prices and the higher passthrough to import prices in the short run. The next part investigates a dynamic stochastic general equilibrium (DSGE) open-economy model, with sticky nominal prices and trade in equities that can potentially explain part of the "home-bias puzzle." The model incorporates monetary and productivity shocks, with equities and nominal forward foreign exchange contracts. Conditional on productivity shocks, there is a negative correlation between home equity returns and returns to human capital, thus generating a home bias. The last part explores results derived by the investigator for present value models of exchange rates to measure the contribution of observed "fundamentals" to the changes in (logs of) exchange rates. The statistic proposed measures the contribution of these fundamentals to changes in asset prices when there are unobserved driving variables. The usefulness of the statistic under various circumstances will be explored. The three major areas of proposed work all involve applied general equilibrium modeling of open economies. All are motivated by empirical work, and all three sections propose empirical work. Any work such as this will ultimately have broader impact in terms of promoting better understanding of the workings of the macroeconomy, and hence better policy making. The first part is directly related to monetary policy making in open economies. The second and third parts propose new methods for examining open economies in very applied contexts.