The Monetary Approach to the Exchange Rate: Rational Expectations, Long-Run Equilibrium and Forecasting
May 1, 1992
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Summary
We re-examine the monetary approach to the exchange rate from a number of perspectives, using monthly data on the deutschemark-dollar exchange rate. Using the Campbell-Shiller technique for testing present value models, we reject the restrictions imposed upon the data by the forward-looking rational expectations monetary model. We demonstrate, however, that the monetary model is validated as a long-run equilibrium condition. Moreover, imposing the long-run monetary model restrictions in a dynamic error correction framework leads to exchange rate forecasts which are superior to those generated by a random walk forecasting model.
Subject: Econometric analysis, Exchange rate assessments, Exchange rate modelling, Exchange rates, Foreign exchange, National accounts, Personal income, Vector autoregression
Keywords: dynamic error, exchange rate, Exchange rate assessments, Exchange rate modelling, Exchange rates, integrating vector, likelihood ratio statistic, Personal income, Phillips-Perron statistics, test statistic, time series, Vector autoregression, WP
Pages:
28
Volume:
1992
DOI:
Issue:
034
Series:
Working Paper No. 1992/034
Stock No:
WPIEA0341992
ISBN:
9781451978803
ISSN:
1018-5941
Notes
Also published in Staff Papers, Vol. 40, No. 1, March 1993.
