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 p erspectives, using monthly data on the deutsche mark-U.S. dollar excha nge rate. Using the Campbell-Shiller technique, we reject the restrict ions imposed on the data by the forward-looking rational expectations monetary model. The monetary model, however, is validated as a long-ru n equilibrium condition. Moreover, imposing the long-run monetary mode l restrictions in a dynamic error-correction framework leads to exchan ge rate forecasts that are superior to those generated by a random wal k forecasting model.