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Exchange Rate Behavior under Full Monetary Equilibrium: An Empirical Analysis

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John H. Makin
Abstract

This paper aims to remedy difficulties with some extant empirical tests of the monetary approach to exchange rate determination. Four problems are addressed: explication of and allowance for real exchange rate changes; imposition of interest parity; use of the forward rate as an unbiased predictor of the spot rate; and modeling implications of official intervention in foreign exchange markets and of possible efforts to sterilize effects of intervention in the monetary base. Empirical tests conducted with monthly data on the dollar-DM exchange rate from March, 1973 -December,1979 do not permit rejection of the complex joint hypothesis represented by equations estimated to test the monetary approach. Still, there remained unexplained a large portion of the behavior of the dollar-DM exchange rate in the 1973-79 monthly sample employed. This result suggests that exchange rates may be viewed as prices determined in asset markets where a large and unsystematic flow of information, not captured by monetary or other variables, produces large, unsystematic movements.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0647.

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Date of creation: Mar 1981
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Handle: RePEc:nbr:nberwo:0647

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  1. Joseph Bisignano & Kevin Hoover, 1980. "Alternative asset market approaches to exchange rate determination," Working Papers in Applied Economic Theory 105, Federal Reserve Bank of San Francisco.
  2. Rudiger Dornbusch, 1980. "Exchange Rate Economics: Where Do We Stand?," NBER Reprints 0090, National Bureau of Economic Research, Inc.
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  3. Caves, Douglas W & Feige, Edgar L, 1980. "Efficient Foreign Exchange Markets and the Monetary Approach to Exchange-Rate Determination," American Economic Review, American Economic Association, vol. 70(1), pages 120-34, March. [Downloadable!] (restricted)
  4. Frenkel, Jacob A, 1977. "The Forward Exchange Rate, Expectations, and the Demand for Money: The German Hyperinflation," American Economic Review, American Economic Association, vol. 67(4), pages 653-70, September. [Downloadable!] (restricted)
  5. John H. Makin, 1981. "International Capital Flows under Full Monetary Equilibrium: An Empirical Analysis," NBER Working Papers 0648, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Dornbusch, Rudiger & Fischer, Stanley, 1980. "Exchange Rates and the Current Account," American Economic Review, American Economic Association, vol. 70(5), pages 960-71, December. [Downloadable!] (restricted)
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