Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/297429 
Year of Publication: 
2023
Series/Report no.: 
Bank of Canada Staff Working Paper No. 2023-44
Publisher: 
Bank of Canada, Ottawa
Abstract: 
This paper investigates exchange rate dynamics in open economies by incorporating bounded rationality. We develop a small open-economy New Keynesian model with an incomplete asset market, wherein decision-makers possess limited foresight and can plan for only a finite distance into the future. The equilibrium dynamics depend on the degree of foresight and the decision-makers' belief-updating behaviors that approximate continuation values at the end of their planning horizons. The limited foresight leads to dynamic overshooting of forecast errors in the real exchange rate across different time horizons, while also differentiating the term structure of expectations. This framework hence provides a micro-foundation for understanding time and forecast horizon variability in uncovered interest parity (UIP) puzzles.
Subjects: 
Exchange rates
Monetary policy transmission
International topics
Business fluctuationsand cycles
JEL: 
E43
E70
F31
F41
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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