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

Ronald MacDonald and Mark Taylor

No 1992/034, IMF Working Papers from International Monetary Fund

Abstract: 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.

Keywords: WP; exchange rate; dynamic error; likelihood ratio statistic; Phillips-Perron statistics; test statistic; integrating vector; time series; Exchange rates; Vector autoregression; Exchange rate modelling; Personal income; Exchange rate assessments (search for similar items in EconPapers)
Pages: 28
Date: 1992-05-01
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Citations: View citations in EconPapers (15)

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Journal Article: The Monetary Approach to the Exchange Rate: Rational Expectations, Long-Run Equilibrium, and Forecasting (1993)
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