## The Monetary Approach to the Exchange Rate: Rational Expectations, Long-Run Equilibrium and Forecasting

_IMF Working Papers, May 1, 1992_

## Source details

**Canonical URL:** [The Monetary Approach to the Exchange Rate: Rational Expectations, Long-Run Equilibrium and Forecasting](https://www.imf.org/en/publications/wp/issues/2016/12/30/the-monetary-approach-to-the-exchange-rate-rational-expectations-long-run-equilibrium-and-784)

## Other formats

- [Markdown version](/en/publications/wp/issues/2016/12/30/the-monetary-approach-to-the-exchange-rate-rational-expectations-long-run-equilibrium-and-784/index.md)
- [Structured JSON version](/en/publications/wp/issues/2016/12/30/the-monetary-approach-to-the-exchange-rate-rational-expectations-long-run-equilibrium-and-784/index.json)
- [Bundle manifest](/en/publications/wp/issues/2016/12/30/the-monetary-approach-to-the-exchange-rate-rational-expectations-long-run-equilibrium-and-784/bundle-manifest.json)

## Bibliographic details
- Authors: Ronald MacDonald, Mark P. Taylor
- Published: May 1, 1992
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451978803.001

---

### Summary
- Re-examines the monetary approach to the exchange rate using monthly data on the deutschemark-dollar exchange rate.
- Using the Campbell-Shiller technique for testing present value models, the authors reject the restrictions imposed upon the data by the forward-looking rational expectations monetary model.
- The monetary model is validated as a long-run equilibrium condition.
- Imposing the long-run monetary model restrictions in a dynamic error correction framework yields exchange rate forecasts superior to those generated by a random walk forecasting model.

### Methodology and Key Findings
- Data: monthly deutschemark-dollar exchange rate.
- Testing approach: Campbell-Shiller technique for present value models.
- Findings:
  - Rejection of forward-looking rational expectations monetary model restrictions when tested against the data.
  - Validation of the monetary model as a long-run equilibrium relationship.
  - Dynamic error correction framework that incorporates long-run monetary model restrictions improves forecast performance relative to a random walk.

### Forecasting Implications
- Forecasts generated from a dynamic error correction model that enforces long-run monetary model restrictions outperform random walk forecasts for the deutschemark-dollar exchange rate.

### Subject Areas and Keywords
- 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

---


_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/the-monetary-approach-to-the-exchange-rate-rational-expectations-long-run-equilibrium-and-784_