Exchange Rates and Fundamentals

50 Pages Posted: 2 Dec 2003

See all articles by Charles M. Engel

Charles M. Engel

University of Wisconsin - Madison - Department of Economics; National Bureau of Economic Research (NBER); University of Washington - Department of Economics

Kenneth D. West

University of Wisconsin - Madison - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: August 2003

Abstract

Standard economic models hold that exchange rates are influenced by fundamental variables such as relative money supplies, outputs, inflation rates and interest rates. Nonetheless, it has been well documented that such variables little help predict changes in floating exchange rates - that is, exchange rates follow a random walk. We show that the data do exhibit a related link suggested by standard models - that the exchange rate helps predict fundamentals. We also show analytically that in a rational expectations present value model, an asset price manifests near random walk behavior if fundamentals are I(1) and the factor for discounting future fundamentals is near one. We suggest that this may apply to exchange rates.

Keywords: Exchange rates, random walk, present value, monetary model, asset price

JEL Classification: F310, F370, G150, G120

Suggested Citation

Engel, Charles M. and West, Kenneth D., Exchange Rates and Fundamentals (August 2003). ECB Working Paper No. 248. Available at SSRN: https://ssrn.com/abstract=457320

Charles M. Engel (Contact Author)

University of Wisconsin - Madison - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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University of Washington - Department of Economics ( email )

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Kenneth D. West

University of Wisconsin - Madison - Department of Economics ( email )

1180 Observatory Drive
Madison, WI 53706
United States
608-262-0033 (Phone)
608-262-2033 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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