This paper tries to model a dynamic determination of foreign exchange rate in an open macroeconomy in which goods and services are freely traded and financial capital flows efficiently for highest returns. For this purpose it becomes necessary to employ a new method contrary to standard methods of dealing with a foreign sector as adjunct to macroeconomy; that is, an introduction of another macroeconomy as a foreign sector. Within this new framework of open macroeconomy, transactions among domestic and foreign sectors are handled according to the principle of accounting system dynamics developed by the author, and the balance of payments is attained. For the sake of simplicity of analyzing foreign exchange dynamics, macro variables such as GDP, its price level and interest rate are treated as outside parameters. Then, eight scenarios are produced and examined to see how exchange rate, trade balance and financial investment, etc. respond to such outside parameters. To our surprise, expectations of foreign exchange rate turn out to play a crucial role for destabilizing trade balance and financial investment. The impact of official intervention on foreign exchange and a path to default is also discussed.
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