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Macroeconomic Implications of Alternative Exchange-Rate Models

Chapter

Abstract

For all economies open to substantial trade and capital flows, exchange rates are central macroeconomic variables. As such, they influence, and are influenced by, all of the important forces of the economy. The general move during the seventies to more flexible exchange rates has given rise to a variety of apparently competing theories of exchange-rate determination. Some of these theories have been subjected to single-equation tests of quasi-reduced-form equations explaining the exchange rate. The partial nature of many of these competing models poses problems of interpretation. On the purely theoretical level,2 the apparently conflicting implications of the various theories are often the consequence of alternative assumptions about what is held constant elsewhere in the economy, and vanish when the theories are embedded in a broader macroeconomic framework. Similarly, the empirical tests depend on different sets of macroeconomic variables that cannot generally be assumed to be independent of each other. In addition, estimation procedures and data samples are seldom used comparably for alternative theories. This poses problems of two types. First, it is not easy to tell to what extent the various models are competitors, rather than alternative renormalizations of the same broad system; and, to the extent that there is competition it is difficult to find comparable tests.

Keywords

Exchange Rate Purchasing Power Parity Flexible Exchange Rate Interest Parity Monetary Shock 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

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© Paul De Grauwe and Theo Peeters 1983

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