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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
  • Mark P. Taylor

Abstract

We re-examine the monetary approach to the exchange rate from a number of perspectives, using monthly data on the deutschemark-dollar exchange rate. Using the Campbell-Shiller technique for testing present value models, we reject the restrictions imposed upon the data by the forward-looking rational expectations monetary model. We demonstrate, however, that the monetary model 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 which are superior to those generated by a random walk forecasting model.

Suggested Citation

  • Ronald MacDonald & Mark P. Taylor, 1992. "The Monetary Approach to the Exchange Rate; Rational Expectations, Long-Run Equilibrium and Forecasting," IMF Working Papers 92/34, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:92/34
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    Keywords

    Exchange rates; Economic models; exchange rate; monetary model; monetary approach; monetary fund; dollar exchange rate;

    JEL classification:

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

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