Credit market imperfections and exchange rate variability

In this paper a two-country overlapping generations model is presented in w hich the roles of financial factors in the international monetary transmiss ion mechanism are studied and whether and how the two types of credit marke t imperfections, limited participation, and costly state verification may c ontribute to the high variability of exchange rates are examined. Liquidity effects generated by monetary disturbances are shown to have qualitatively similar effects on the world economy in the perfect information case and i n the costly information case. However, quantitative differences provide di fferent predictions about the variability of economic: variables in the wor ld economy.