For period t=0 in my simplified model, initial money holdings are 0, and so the consumption function is given by: Consumption = a (Wages), where 0. In a free market, a trade surplus should increase the value of a country’s currency. People want to be paid in local money, creating demand for the currency, which in turn raises its value. View Notes - ecos30102016s1notes11 from ECOS 3010 at The University of Sydney. ECOS3010 Monetary Economics Lecture Notes 11 Prof. Amy Sun University of Sydney Lagos & Wright with money.

Inventories and Money Holdings in a Search Economy

Vol. 58, No. 4 (Jul., 1990), pp. 929-950 (22 pages)

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Abstract

We analyze steady state equilibrium of the circular flow of money and goods in a continuous time model with infinitely lived agents. Workers sell their endowments of labor on a Walrasian labor market. Labor is used in production, the output of which flows into inventories. Capitalists consume directly out of their own inventories and use remaining inventories in a retail market. The retail market is characterized by random sequential search with prices set by capitalists on a take-it or leave-it basis. Workers thus receive a continuous flow of wages and spend money in discrete jumps at times set by a Poisson process. The equilibrium distribution of money holdings is the asymptotic steady state of this stochastic process. The economy has a unique uniform price steady state equilibrium. The more rapid the search process in the retail market the higher the absolute retail price and wage, and the higher the real wage. The instantaneous effect of an equal per capita infusion of money is to raise the price, wage, real wage, and transactions rate. The immediate post-infusion price and wage can overshoot their new asymptotic values.

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Econometrica publishes original articles in all branches of economics - theoretical and empirical, abstract and applied, providing wide-ranging coverage across the subject area. It promotes studies that aim at the unification of the theoretical-quantitative and the empirical-quantitative approach to economic problems and that are penetrated by constructive and rigorous thinking. It explores a unique range of topics each year - from the frontier of theoretical developments in many new and important areas, to research on current and applied economic problems, to methodologically innovative, theoretical and applied studies in econometrics.

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The Econometric Society is an international society for the advancement of economic theory in its relation to statistics and mathematics.

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Modern Economy
Vol. 4 No. 7 (2013) , Article ID: 34706 , 11 pages DOI:10.4236/me.2013.47051

Exchange Rate and Current Account Dynamics with Habits over Consumption and Money Holdings

¹Faculty of Economics, Ritsumeikan University, Kusatsu, Japan

²Institute of Social and Economic Research, Osaka University, Ibaraki, Japan

Email: ^*gombi@ec.ritsumei.ac.jp

Copyright © 2013 Ichiro Gombi, Shinsuke Ikeda. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

Received February 18, 2013; revised March 30, 2013; accepted April 30, 2013

Keywords: Habit formation; Money; Exchange rate; Current account

ABSTRACT

Solve For The Steady State Value Of Real Money Holdings Results

Incorporating two independent habits over consumption and money holdings into a small country model, we examine the adjustment dynamics of the current account and the exchange rate to expansionary monetary and fiscal shocks under two alternative policy regimes: (1) the endogenous income transfer regime; and (2) the endogenous fiscal spending regime. In response to the shocks under regime (1), the exchange rate depreciates on impact and in the long run whereas it appreciates (depreciates) in transition if preferences for real money balances exhibit distant (adjacent) complementarity. Under regime (2), the consumption habits and the monetary habits jointly generate possibly non-monotonic current account dynamics. An induced increase in fiscal spending in regime (2) can generate a current account surplus in the case where the monetary habits exhibit strong distant complementarity.

1. Introduction

The academic as well as practical concerns about the fluctuation of exchange rates and the movement of the current account grow as the integration of the world economy progresses in the recent decades. To describe jointly the dynamics of exchange rates and the current account, there has been cumulative theoretical research that is conducted in the dynamic optimization framework. The seminal work by Obstfeld [1] is the first attempt, which specifies consumer preferences in such non-time separable form as endogenous time preferences. Mansoorian [2] and other related articles (e.g., Mansoorian and Neaime [3]) propose habit models as an alternative empirically relevant specification to examine monetary phenomena in the open economy setting. Although the studies successfully show that incorporating habit formation helps to understand open macroeconomic phenomena, the framework is restricted in the following two aspects: first, the crawling peg exchange-rate regime is assumed, so that the exchange rate is exogenously given; second, habit is specified over the sub-utility defined as the homothetic bundle of consumption and real money balances. Although these specifications enable one to apply straightforwardly the implication of habit formation to monetary issues of open economies, we need a more comprehensive framework to examine the exchangerate and current-account dynamics by focusing on specific roles that are played by habits over real money balances and over consumption.

The purpose of this article is to do it: we examine the dynamic adjustment of the current account and the exchange rate to monetary and fiscal policies by introducing the money-specific habits as well as the consumption-specific habits in the form of weakly nonseparable preferences.¹ This specification of habits enables us to allow for different degrees of habit strength between consumption and money.² Whereas consumer preferences are assumed to be of the type of adjacent complementarity,³ we will not put any restriction on the degree of monetary habits because there is no empirical report on the strength of habits on real money balances.

By assuming that the government’s budget is always balanced we analyze the effects of macroeconomic policies under two alternative regimes: (1) the endogenous income transfer regime, in which income transfer payments (τ) are endogenously determined so as to retain the balanced budget for exogenous values of the money growth rate (μ) and of fiscal spending (g); and (2) the endogenous