Exchange Rates and Fundamentals

By Charles M. Engel, Ken West. Journal of Political Economy, 2005

1,097 citations recorded by the source corpus.

We 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 argue that this result helps explain the well‐known puzzle that fundamental variables such as relative money supplies, outputs, inflation, and interest rates provide little help in predicting changes in floating exchange rates. As well, we show that the data do exhibit a related link suggested by standard models—that the exchange rate helps predict these fundamentals. The implication is that exchange rates and fundamentals are linked in a way that is broadly consistent with asset‐pricing models of the exchange rate.

Subfields: Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/efd9df2528d7bc84ac70b2b68b18a47d785695d5

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In Economics and Econometrics

Citations in the corpus

On the unstable relationship between exchange rates and macroeconomic fundamentals (2013, neutral): “The nal subsection provides intuition on the mechanism leading to this instability.”
Exchange Rate Fundamentals and Order Flow (2012, neutral): “This analysis complements the recent results of Engel and West (2004) .”
Heterogeneous expectations, exchange rate dynamics and predictability (2007, positive): “Engel and West (2005) offer an explanation for the inability to forecast nominal exchange rates using fundamental variables.”
The dynamic impacts of financial institutions on economic growth: Evidence from the European Union (2010, neutral): “In such a case, it is too restrictive to evaluate the validity of a model based on out-of-sample tests (Engel and West, 2005).”
Exchange Rate Disconnect in General Equilibrium (2017, neutral): “Meese and Rogoff (1983) puzzle: the nominal exchange rate follows a random-walk-like process, which is not robustly correlated, even contemporaneously, with macroeconomic fundamentals (see also Engel and West 2005).”
Rational Forecasts or Social Opinion Dynamics? Identification of Interaction Effects in a Business Climate Survey (2009, neutral): “Weidlich, W. and G. Haag, 1983, Concepts and Methods of a Quantitative Sociology, Berlin, Springer.”
Can Exchange Rates Forecast Commodity Prices (2008, neutral): “Engel and West (2005), for example, argue that it is not surprising that a random walk forecast outperforms fundamental-based models, as in a rational expectation present-value model, if the fundamentals are I(1) and the discount factor is near one, exchange rate should behave as a near-random walk.”
Getting Beyond Carry Trade: What Makes a Safe Haven Currency? (2011, neutral): “In the same table, we also replace the VIX, as a measure of global risk aversion, with the alternatives presented in Table 2 (columns (5) to (9)).”
Exchange Rate Predictability (2013, positive): “Engel and West (2005, 2006) and Molodtsova and Papell (2009) propose fundamentals based on a Taylor rule for monetary policy (Taylor, 1993).”