Using an expanded version of the purchasing-power-parity condition we
construct simultaneous equation models for three key exchange rates wh
ich incorporate meaningful long-run equilibrium relationships and comp
lex short-run dynamics. We show that fully dynamic out-of-sample forec
asts from these models are capable of significantly outperforming thos
e 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 for
ecasts.