This paper uses a dynamic general equilibrium optimizing two-country model to analyze how the formation of exchange rate expectations shapes the effects of monetary policy shocks in open economies. The model implies that the short-run output effects of permanent monetary policy shocks diminish...

The inability to reconcile observed levels of foreign exchange rate volatility with predictions derived from rational expectations models represents one of the most persistent challenges in international finance. This paper shows that such excess volatility puzzles arise from informational...