time：2023-03-01
This paper studies a model where nominal exchange rates are determined by asymmetric information. In a two-country, two-currency search-theoretic framework, buyers have complete information, while sellers have incomplete information regarding the real value of foreign currencies. In this model, no restrictions are placed on which currency to use for transactions, but due to the uncertainty sellers face about the real value of foreign currency, domestic currency becomes the preferred medium of exchange, leading to the emergence of different currency regimes in equilibrium. The impact of information asymmetry and economic openness on the nominal exchange rate is ambiguous because they interact with various currency regimes.
In this model, when buyers hold both currencies, if the uncertainty of one currency increases, they might substitute it with the other, leading to depreciation. However, if they only hold their domestic currency, they would signal its high value by retaining more of it, leading to an appreciation of that currency. The type of currency regime thus determines the effect of uncertainty on the nominal exchange rate. Similarly, economic openness affects exchange rates depending on the currency regime. More frequent international interactions increase foreign currency demand, leading to higher seigniorage revenue and influencing inflation targets.
The paper also explores a policy game between two central banks in setting inflation targets. Due to information asymmetry and economic openness, central banks' inflation targets depend on the inflationary pressures from the other country’s currency uncertainty. Economic openness tends to push both central banks to adopt higher inflation targets.
This research provides a new perspective on monetary search theory and expands the theoretical framework for exchange rate determination, particularly in the context of monetary policy uncertainty and information asymmetry, offering better explanations for real-world exchange rate fluctuations.