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Working Paper Summaries (WP/92/1 - WP/92/47)
Article

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

Author(s):
International Monetary Fund
Published Date:
August 1992
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This paper re-examines the monetary model of the exchange rate from a number of complementary perspectives. Using data for the deutsche mark-U.S. dollar exchange rate during 1976-90, the paper demonstrates the following: First, the static monetary approach to the exchange rate is valid when it is considered as a long-run equilibrium condition. Second, when the exchange rate fundamentals suggested by the monetary model are assumed, the speculative bubbles hypothesis is rejected. Third, the full set of rational expectations restrictions imposed by the forward-looking monetary model can be used to generate a dynamic error-correction exchange rate equation that has robust in-sample and out-of-sample properties and is superior to a random walk (the usual benchmark) in post-sample forecasting.

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