Frankel interest rate model

Question 1

what did this model do ? 2 points

Answer 1

• Dornbusch model: does not take into
account inflation expectations
• 1970’s: Inflationary scenarios
• Frankel (1979): model accommodates the
“flexible price” and “sticky price”
monetarist models as special cases.

Question 2

learn equation combining flexible and sticky model

Answer 2

LEARN IT

• Fully flexible monetarist school: markets clear
instantaneously: θ=∞
• Frankel model: goods and labour market prices
adjust slowly to shocks: θ

Question 3

4. Explain the link between the Dornbusch sticky price model and the Frankel interest rate differential model
   (4 points)

Answer 3

• Frankel : model accommodates the “flexible price” and “sticky price” monetarist models as special cases.
• Frankel generalization of the Dornbusch model: speed of adjustment of goods market: important determining the short- run exchange rate
• Disequilibrium of the real interest rates: exchange rate will deviate from its long- run equilibrium value
• Domestic interest rate lower than foreign interest rate: expected appreciation of the exchange rate.