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On the unstable relationship between exchange rates and macroeconomic fundamentals

  • Bacchetta, Philippe
  • van Wincoop, Eric

Survey evidence shows that the relationship between the exchange rate and macro fundamentals is perceived to be highly unstable. We argue that this unstable relationship naturally develops when structural parameters in the economy are unknown. We show that the reduced form relationship between exchange rates and fundamentals is then driven not by the structural parameters themselves, but rather by expectations of these parameters. These expectations can vary significantly over time as a result of perfectly rational “scapegoat” effects. These effects can be expected to hold more broadly in macro and finance beyond the application to exchange rates in this paper.

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File URL: http://www.sciencedirect.com/science/article/pii/S0022199613000688
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Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 91 (2013)
Issue (Month): 1 ()
Pages: 18-26

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Handle: RePEc:eee:inecon:v:91:y:2013:i:1:p:18-26
DOI: 10.1016/j.jinteco.2013.06.001
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505552

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