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

Author

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  • Ronald Macdonald

    (International Monetary Fund)

  • Mark P. Taylor

    (International Monetary Fund)

Abstract

We reexamine the monetary approach to the exchange rate from several perspectives, using monthly data on the deutsche mark-U.S. dollar exchange rate. Using the Campbell-Shiller technique, we reject the restrictions imposed on the data by the forward-looking rational expectations monetary model. The monetary model, however, 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 that are superior to those generated by a random walk forecasting model.

Suggested Citation

  • Ronald Macdonald & Mark P. Taylor, 1993. "The Monetary Approach to the Exchange Rate: Rational Expectations, Long-Run Equilibrium, and Forecasting," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 89-107, March.
  • Handle: RePEc:pal:imfstp:v:40:y:1993:i:1:p:89-107
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange

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