Taiwan has experienced a huge trade surplus and a rapid growth in the money supply since the 1970s. This paper constructs and estimates a model that takes into account the demand for international reserves, price levels, and the joint determination of the exchange rate, the demand for money, and the balance of payments in Taiwan during the period 1979 to 1990. We focus our attention especially on the period from 1986 to 1990 when foreign reserves rapidly accumulated and the appreciation expectations prevailed. Our estimate of exchange rate reaction function accords with what is expected. The exchange rate appreciations had a favourable effect on the stabilization of price levels. In addition, the exchange rate and its expectations play important roles in the demand for money equation.
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