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Myths and Misconceptions of Exchange Rates

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Author Info
Jocelyn Horne () (Department of Economics, Macquarie University)

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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).

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File URL: http://www.econ.mq.edu.au/research/2001/5-2001Horne.PDF
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Publisher Info
Paper provided by Macquarie University, Department of Economics in its series Research Papers with number 0105.

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Length: 35 pages.
Date of creation: May 2001
Date of revision:
Handle: RePEc:mac:wpaper:0105

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Postal: Sydney NSW 2109
Web page: http://www.econ.mq.edu.au/
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Related research
Keywords: exchange rates; international monetary reform;

Find related papers by JEL classification:
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation

References listed on IDEAS
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  1. Flood, Robert P., 1987. "Comments on speculation and the volatility of foreign currency exchange rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 26(1), pages 57-62, January. [Downloadable!] (restricted)
  2. Leonardo Bartolini & Gordon M. Bodnar, 1995. "Are Exchange Rates Excessively Volatile? And What Does "Excessively Volatile" Mean, Anyway?," IMF Working Papers 95/85, International Monetary Fund.
    Other versions:
  3. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December. [Downloadable!] (restricted)
  4. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February. [Downloadable!] (restricted)
  5. Singleton, Kenneth, 1987. "Speculation and the volatility of foreign currency exchange rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 26(1), pages 9-56, January. [Downloadable!] (restricted)
  6. Chris Ryan & Christopher Thompson, 2000. "Inflation Targeting and Exchange Rate Fluctuations in Australia," RBA Research Discussion Papers rdp2000-06, Reserve Bank of Australia. [Downloadable!]
  7. Rudiger Dornbusch, 1980. "Exchange Rate Economics: Where Do We Stand?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1980-1), pages 143-206. [Downloadable!]
  8. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June. [Downloadable!] (restricted)
  9. Horne, Jocelyn, 1983. "The asset market model of the balance of payments and the exchange rate: A survey of empirical evidence," Journal of International Money and Finance, Elsevier, vol. 2(2), pages 89-109, August. [Downloadable!] (restricted)
  10. Johnson, Harry G, 1977. "The Monetary Approach to Balance of Payments Theory and Policy: Explanation and Policy Implications," Economica, London School of Economics and Political Science, vol. 44(175), pages 217-29, August. [Downloadable!] (restricted)
  11. Arize, Augustine C & Osang, Thomas & Slottje, Daniel J, 2000. "Exchange-Rate Volatility and Foreign Trade: Evidence from Thirteen LDC's," Journal of Business & Economic Statistics, American Statistical Association, vol. 18(1), pages 10-17, January.
  12. Brunner, Karl & Meltzer, Allan H., 1987. "Bubbles and other essays," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 26(1), pages 1-8, January. [Downloadable!] (restricted)
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