Overvalued and undervalued exchange rates in an equilibrium optimizing model

Intertemporal equilibrium optimizing models have recently become the standard framework for analyzing such macroeconomic issues as terms of trade, fiscal or trade policy, international transfers, supply shocks, and technological progress. In the model Lizondo presents, sustainable fiscal policies produce an equilibrium real exchange rates, and unsustainable policies produce misaligned exchange rates. When the exchange rate is overvalued, maintaining present fiscal policies means the present value of lifetime public sector spending would be higher than the present value of taxes. For Lizondo's model to be used to obtain welfare conclusions about the use of overvalued or undervalued exchange rates, it would be necessary to assign some social value to public sector expenditure. Other fruitful modifications of the model would be to incorporate investment activity as well as money - the latter of which would allow for discussion of the effects of monetary policy, exchange rate arrangements, and nominal exchange rate policy.Economic Stabilization,Economic Theory&Research,Macroeconomic Management,Environmental Economics&Policies,Achieving Shared Growth