Working Paper: NBER ID: w1732
Authors: Richard Meese; Kenneth Rogoff
Abstract: The main result of Meese and Rogoff [1983 a,b] is that small structural exchange rate models forecast major dollar exchange rates no better than a naive random walk model. This result obtains even when the model forecasts are based on actual realized values of the explanatory variables. Here we improve our methodology by implementing a new test of out-of-sample fit; the test is valid even for overlapping long-horizon forecasts. We find that the dollar exchange rate models perform somewhat less badly over the recent Reagan regime period than over the episodes studied previously. The methodology is also applied to the mark/yen and mark/pound exchange rates, and to real exchange rates. Finally, we test to see if real exchange rates and real interest differentials can be represented as a cointegrated process. The evidence suggests that there is no single common influence inducing nonstationarity in both real exchange rates and real interest differentials.
Keywords: Exchange Rates; Monetary Models; Real Interest Differentials; Cointegration
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| real interest rate differential (E43) | real exchange rates (F31) |
| small structural exchange rate models (F31) | major dollar exchange rates (F31) |
| real exchange rates (F31) | naive random walk model (C29) |
| real exchange rates (F31) | real interest differentials (E43) |