Myths and Misconceptions of Exchange Rates

Jocelyn Horne

No 105, Research Papers from Macquarie University, Department of Economics

Abstract: This paper examines and dissects ten popular "suspect" conjectures about exchange rates. The conjectures are the following: (1) Economists know what determines the exchange rate (2) Flexible exchange rates are unstable due to destabilising speculation (3) Flexible exchange rates are excessively volatile (4) The foreign exchange market is efficient (5) Purchasing Power Parity holds (6) There is no risk in foreign exchange (7) Volatile exchange rates are harmful to trade (8) Depreciating exchange rates trigger a "vicious" inflationary circle (9) Countries with current account deficits have depreciating exchange rates and (10) Low exchange rate pass-through provides a "free lunch". The main message is that there is weak or no theoretical or empirical support for the majority of the conjectures (myths 3, 4, 6, 7, 8 and 9). Only one proposition, relative PPP, has strong empirical support but its policy relevance is weakened by the difficulty of interpreting departures from PPP. The remaining group for which there is inconclusive support presents the greatest challenge to research and policy as it includes conjecture (1).

Keywords: exchange rates; international monetary reform (search for similar items in EconPapers)
JEL-codes: C43 F33 (search for similar items in EconPapers)
Pages: 35 pages.
Date: 2001-05
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