KDI 경제정보센터

I develop a general characterization of the effect that market incompleteness has on exchange rate dynamics. On the one hand, it weakens the pass-through from a country‘s marginal utility shocks to its own exchange rate movements; on the other hand, it gives rise to additional variations in exchange rates and propagates one country‘s marginal utility shocks to other countries‘ exchange rate movements. This novel international spill-over effect gives rise to both exchange rate disconnect from local fundamentals and exchange rate comovements in the cross-section of currencies, offering a novel channel for understanding these salient features of exchange rate behaviors.