THE SPECIFICATION OF MONEY DEMAND, FISCAL-POLICY, AND EXCHANGE-RATE DYNAMICS

This paper incorporates the Holmes and Smyth (1972) specification, tha t is, the transactions demand for money should depend on consumer expe nditure rather than national income, into the Dornbusch (1976) model. Based on such an amended model, we focus on how exchange rates adjust over time following an anticipated permanent increase in government sp ending. It is found that whether the domestic currency will depreciate or appreciate following a balanced-budget fiscal expansion is sensiti ve to plausible specification in the money demand function. In additio n, it is also found that the misadjustment pattern of exchange rate ca n be observed in response to a balanced fiscal expansion, even if the system displays the saddlepoint stability rather than the global insta bility proposed by Aoki (1985).