Ronald MacDonald

Exchange Rates and Economic Fundamentals: A Methodological Comparison of Beers and Feers

The analysis of exchange rate behavior has been a perennial topic in international monetary economics. One strand of this literature relates to the explanation of observed movements in nominal and real exchange rates in terms of relevant economic variables. A different strand focuses on assessing exchange rates relative to economic fundamentals and coming to a judgement as to whether a particular exchange rate is misaligned, i.e., over- or undervalued. One approach taken in this latter strand of research that has been developed by Williamson (1994) involves the calculation of what is called the Fundamental Equilibrium Exchange Rate (FEER). In this approach the equilibrium exchange rate is defined as the real effective exchange rate that is consistent with macroeconomic balance, which is generally interpreted as when the economy is operating at full employment and low inflation (internal balance) and a current account that is sustainable, i.e., that reflects underlying and desired net capital flows (external balance). This exchange rate concept is denoted as “fundamental” in that it abstracts from short-term factors and emphasizes instead determinants that are important over the medium term. An assessment of a country’s exchange rate can be made by comparing its current level with the calculated FEER

The monetary model of the exchange rate: long-run relationships, short-run dynamics and how to beat a random walk

Abstract The monetary model is re-examined for the sterling—dollar exchange rate. First, it is demonstrated, using a multivariate cointegration technique, that an unrestricted monetary model is a valid framework for analyzing the long-run exchange rate. Second, we find, once proper account has been taken of the short-run data dynamics, that an unrestricted monetary model outperforms the random walk and other models in an out-of-sample forecasting contest. (JEL F31).

Panel unit root tests and real exchange rates

Using two real exchange rate data sets, we implement a new form of unit root test. In particular, we use a panel unit root test to jointly test for a unit root in a group of OECD real exchange rates for the recent floating experience. In contrast to many other unit root tests using a similar data set, we are able to reject the null hypothesis of a unit root.

Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues

In this paper we present an overview of a number of issues relating to the equilibrium exchange rates of transition economies of the former soviet bloc. In particular, we present a critical overview of the various methods available for calculating equilibrium exchange rates and discuss how useful they are likely to be for the transition economies. Amongst our findings is the result that the trend appreciation usually observed for the exchange rates of these economies is affected by factors other than the usual Balassa-Samuelson effect, such as the behaviour of the real exchange rate of the open sector and regulated prices. We then consider three main sources of uncertainty relating to the implementation of an equilibrium exchange rate model, namely: differences in the theoretical underpinnings; differences in the econometric estimation techniques; and differences relating to the time series and cross-sectional dimensions of the data. The ensuing three-dimensional space of real misalignments is probably a useful tool in determining the direction of a possible misalignment rather than its precise size.

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

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.

Equilibrium exchange rates

List of Contributors. 1. Introduction: Equilibrium Exchange Rates R. MacDonald, J.L. Stein. 2. What Do We Really Know about Real Exchange Rates? R. MacDonald. 3. The Evolution of the Real Value of the US Dollar Relative to the G7 Currencies J.L. Stein. 4. A Macroeconomic Balance Framework for Estimating Equilibrium Exchange Rates H. Faruqee, et al. 5. Feers: A Sensitivity Analysis R. Driver, S. Wren-Lewis. 6. Productivity, Government Spending and the Real Exchange Rate: Evidence for OECD Countries M.D. Chinn. 7. Fundamentals of the Real Dollar-Pound Rate: 1871-1994 N.C. Mark. 8. Nominal Equilibrium Exchange Rate Models: A Panel Perspective S. Husted, R. MacDonald. 9. What Determines Real Exchange Rates: The Long and Short Of It R. MacDonald. 10. Exchange Rates and Economic Fundamentals: A Methodological Comparison of Beers and Feers P.B. Clark, R. MacDonald. 11. Japanese Effective Exchange Rates and Determinants: A Long-Run Perspective J. Nagayasu. Index.

Long-Run Exchange Rate Modeling: A Survey of the Recent Evidence

In this paper the recent literature on long-run exchange rate modeling is surveyed. In particular, we review the voluminous literature that tests for a unit root in real exchange rates and the closely related work on testing for a unit root in the residual from a regression of the nominal exchange rate on relative prices. We argue that the balance of evidence is supportive of the existence of some form of long-run exchange rate relationship. The form of this relationship, however, does not accord exactly with a traditional representation of the long-run exchange rate, and we offer some potential explanations.

Currency forecasters are heterogeneous: confirmation and consequences

Using a disaggregated international survey database we demonstrate that foreign exchange forecasters hold heterogeneous expectations. We find that a major cause of these differences of opinion is the idiosyncratic interpretation of widely available information, and that this heterogeneity translates into economically meaningful differences in forecast accuracy. Finally, we show that such disagreements are key variables in determining market trading volume.

ON FUNDAMENTALS AND EXCHANGE RATES: A CASSELIAN PERSPECTIVE

Using an expanded version of the purchasing-power-parity condition we construct simultaneous equation models for three key exchange rates which incorporate meaningful long-run equilibrium relationships and complex short-run dynamics. We show that fully dynamic out-of-sample forecasts from these models are capable of significantly outperforming those of a random walk model over horizons as short as 3 months, and that they are also more accurate than the vast majority of professional forecasts.

Estimation of the Equilibrium Real Exchange Rate for South Africa

Based on the Johansen cointegration estimation methodology, much of the long-run behavior of the real effective exchange rate of South Africa can be explained by real interest rate differentials, GDP per capita (both relative to trading partners), real commodity prices, trade openness, the fiscal balance, and the extent of net foreign assets. On the basis of these fundamentals, the real exchange rate in early 2002 was found to be significantly more depreciated with respect to the estimated equilibrium level. The half-life of the deviation of the real exchange rate from the estimated equilibrium one was found to be somewhat more than two years.