TITLE:
Exchange Rate and Current Account Dynamics with Habits over Consumption and Money Holdings
AUTHORS:
Ichiro Gombi, Shinsuke Ikeda
KEYWORDS:
Habit Formation; Money; Exchange Rate; Current Account
JOURNAL NAME:
Modern Economy,
Vol.4 No.7,
July
17,
2013
ABSTRACT: 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.