Working Paper: NBER ID: w0863
Authors: Peter R. Hartley
Abstract: Many models of exchange rate determination imply that movements in money supplies and demands should result in movements in exchange rates. Hence, if rational agents are attempting to forecast exchange rate movements, they should in the first instance forecast movements in the supplies of and demands for money balances. Furthermore, if these underlying variables follow some stable autoregressive processes agents should use those processes to make their forecasts. If we identify the forward rate with the market's expectation for the future spot rate, rationality of expectations will imply testable cross-equation restrictions in a joint model of the autoregressions and exchange rate forecasting equation. This strategy is implemented in the paper using data on the L UK/$US and DM/$US exchange rates from the recent floating rate period.
Keywords: Exchange Rates; Rational Expectations; Monetary Policy
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Rational expectations (D84) | Exchange rate movements (F31) |
| Money supply and demand (E41) | Exchange rate movements (F31) |
| Exogenous variables (anticipated) (C51) | Exchange rate movements (F31) |
| Exogenous variables (unanticipated) (C29) | Exchange rate movements (F31) |
| Rational expectations (D84) | Testable cross-equation restrictions (C20) |
| Money supply changes (E51) | Exchange rate movements (F31) |