$f_t-s_t=i_t-i_t^{*}={\overline{i}}_t$ Covered Interest Parity. (I)

$s_t=\left(\lambda -1\right){\overline{i}}_t+{\overline{P}}_t-ZX\Delta s_t+z_t$ Flexible spot rate. (II)

$f_t=\lambda {\overline{i}}_t+{\overline{P}}_t-ZX\Delta s_t+z_t$ Flexible forward rate. (III)

$e_t=D{u}_t-FX\Delta s_t+v_t$ Changes in the monetary base. (IV)

${\overline{i}}_t=E\left(\Delta {\overline{P}}_{t+1}|I_t\right)+{\overline{r}}_t+\Lambda e_t-HX\Delta s_t$ Interest rate differential. (V)

$E\left({\overline{P}}_{t+1}|I_t\right)=C\left(D{u}_t-FX\Delta s_t+v_t\right)$ Expected inflation. (VI)

$\Delta {\overline{P}}_{t+1}=C\left(D{u}_t-FX\Delta s_t+v_t\right)+x_{t+1}$ Actual inflation. (VII)

Definitions:

${\overline{P}}_t$ Price level differential in logs.

${\overline{r}}_t$ Real interest rate differential.

${\overline{i}}_t$ Nominal interest rate differential.

u_t Actual minus natural rate of unemployment.

Shocks and restrictions:

$v_t=V{v}_{t-1}+{\nu }_t$ , $u_t=U{u}_{t-1}+w_t$ , ${\overline{r}}_t=R{\overline{r}}_{t-1}+y_t$ , $z_t=z_{t-1}+{\epsilon }_t$ . C, D, Λ, α and h are all ≥0 while V, U and R are all ≥0 but less than 1.0. Random variables w_t, x_t, y_t, ν_t and ε_t have zero means, zero initial values, are uncorrelated and orthogonal. $1\ge F\ge 0$ , $Z=\alpha \left(1+F\right)X$ and $H=h\left(1-F\right)$ .