Why Is It So Difficult To Forecast Exchange Rate Movements?

1240 words - 5 pages

The stability of currency values plays a significant role for economic and financial stability. It is not difficult to see the exchange rate fluctuations are widely regarded as damaging. As the movements of the exchange rate have significant and large effects on the trade balance, resource allocation, domestic prices, interest rate, national income and other key economic variables. Then can exchange rate movements be predicted by these fundamental economic variables?
Economists have long taken the view that economic fundamentals determine exchange rates. Nevertheless, in the early 1970s, after the collapse of fixed exchange rate regimes of the Bretton Woods system, excess volatility, nonlinear and disorderly movements in exchange rates became mysteries that traditional exchange rate theory cannot explain. Recent scholar concluded “no definitive evidence that economic variable can forecast exchange rate for currencies of nations with similar inflation rates" which is known as “the disconnect puzzle” from Meese and Rogoff’s studies (1983). Thus, this essay aims to explain why is it apparently so difficult to forecast exchange rate movements, and to provide evidence from the relevant literature and the reference of three popular fundamentals-based models, including Monetary Model and Mundell-Fleming Model.
To put it simply, the exchange rate is a price. As with any other market, price is determined by supply and demand. Whenever they are not equivalent, the exchange rate would change. However, the reality comes to be far more complicated.
Monetary Model
The leading model, Monetary Model links exchange rate movements to the balance of payment, which is used for medium to long term analysis. The following assumptions constitute the building blocks of the Monetary Model. Firstly, the aggregate supply curve is vertical at all times, which implies perfect price flexibility that clear both money and good markets. Secondly, the purchasing power parity relationship, which ensures the equilibrium of exchange rate. Thirdly, the demand for money is a stable function of national income and price level by using the Cambridge quantity equation.
The most obvious problem is that these assumptions have simplified realities. The based assumptions, money demand equations, purchasing power parity perform poorly under the real world conditions (Engel 2000). The money demand equation has proven to be unstable, especially in the America and the purchasing power parity theory may not hold in the long run. Another problem is that the Monetary Model concentrates only on the equilibrium of money market and leave the fundamentals adjust freely to clear another five markets under the open economy. Moreover, income is an exogenous variable in the model, which implies consumption is depend on interest rather than income level. Consequently, since the building blocks of the Monetary Model have broken down, it surely cannot adequately explain or forecast the facts of...

Find Another Essay On Why Is It so Difficult to Forecast Exchange Rate Movements?

Why is it difficult to achieve economic stability in First Nations in Canada?

1025 words - 5 pages -Aboriginal users” (346). Ethically, it is challenging to understand why their contributions were not counted as equal. There must have been some individuals who understood that the marginalization of Aboriginal, especially in terms of the economy was ethically wrong. A modernization policy was put in effect in 1970, The Indian Economic Development Fund, to fund only legal (registered, status) Indians. It provided loans (direct and guaranteed) or

What is so Difficult to Understand About Mistletoe?

2968 words - 12 pages with a chuckle. “My fault.” “No, it really wasn’t. Don’t worry.” They’re silent again, both red-cheeked and too nervous to look at each other. This time it is Asuka’s voice that cuts against the quiet tension as she walks, hand in hand with Mari, past them. “You’re not in middle school. What is so difficult to understand about mistletoe. I swear to god-“ and then her voice is gone as Mari tugs her away before gracing the two with a small smile

Football: Why Is It So Popular Today?

1043 words - 5 pages Understanding football is the main course into knowing why it is so popular. Many other sports do not compare to the impact football has on players and on the fans of its kind. We live in a world that is so diverse and any entertainment comes to us natural. Gambling seems to be the most entertainment is our human society today. We long for Gladiator type sports and games for public entertainment. To get a better understanding on why football is

Why Is It So Important to Look for the True Identity?

1409 words - 6 pages he discards his father’s irritation. He founds a true identity of him by discovering Christianity, which fits best for him and escaping from his father. Nwoye exhibits his desire for an exploration of true self, and after he finally found it, it gave him peaceful and steady life without the pressure from Okonkwo. Things Fall Apart gives a reason why looking for a true identity is so important to people by characterizing Nwoye and his life of

Management of change, and why is it so effective?

1805 words - 7 pages . 2002: 346). So it comes to the question, why is it a necessity for organisations to change? And what affects upon effective change management?Robbins et al discusses that change is driven by five main points; the nature of the workforce, technology, competition, social trends and world politics (Robbins, S.P. et al 2004: 568). The nature of the workforce affects change due to the diversity of organisation itself. As the organisation grows in size

'Why is it so important for academics and marketing managers to understand the impact of external influences on consumer behaviour?'

2157 words - 9 pages to divide the market into segments, so that they can examine certain areas more closely. It has been claimed that there are five main determinants of external influences: situation, family, culture, social class and personal influence. This essay will try to assess the reasoning behind why these factors need to be considered by academics when investigating consumer behaviour.Marketers are looking for quick easy solutions for finding marketing

The problems of why Immigrants finds it difficult to find employment

1062 words - 4 pages to tells the newcomers. In conclusion immigrants found it very difficult to find jobs when Canadian employers don't recognize their foreign degree and training certificates, don't recognize their foreign work experience from another country and also the shortage of agencies' support that is supposed to help new comers to settle down. Although Canada is known for its multiculturalism and its highest parentage immigration rate, Canada still has

Why was it difficult to achieve a viable nuclear strategy during the Cold War?

1424 words - 6 pages increasing the deterrence effect (i.e. Soviets fear consequences of attacking US more so than previously). This however seems to be oppositional to the concept of MAD, the US is now more capable of defending itself against a retaliatory strike from the Soviet Union if the US were to strike first, thus causing a breakdown in the requirements for MAD to hold. Whilst the US has an advantage in this instance and the effect would have been presumed to

Understanding the Exchange Market Rate - Pound to US Dollar (GBP/USD) Exchange Rate

3315 words - 13 pages The fluctuation or well known as the exchange market is the rate at which one currency will be exchange for another. It also regarded as the value of one country’s currency in the terms of another currency. The fluctuation was determined in the foreign exchange market (Wikipedia, 2014). The fluctuation rate is not permanent sometime in one day the fluctuation rate can change from high to low and from low to high. Hard currency is any global

Why is privacy probably one of the most difficult ethical area for journalists to define?

2519 words - 10 pages Why is privacy probably the most important and difficult ethical area for journalists to define?Ethical principals are hard to define because moral judgements are essentially the decision of each individual. Broadly defined ethical codes may be useful to some journalists but responsibility falls on personal conscience.Also, Frost tells us:"There are too many variables around the circumstances of each invasion of privacy to allow for hard-and

Why is the resurrection so important to christian faith

1013 words - 4 pages Question: Why is the resurrection so important to Christian faith?Even now, 2000 years after his death Jesus Christ is followed and looked up to. But perhaps more important than what he said was what he did. His actions were amazing, superhuman even, but eventually led to his crucifixion. It was after his death that Jesus performed his most amazing deed. He was put in his tomb on Friday, on Sunday three female friends went to embalm him... and

Similar Essays

What Is The Turing Test, And Why Is It So Difficult To Pass?

2188 words - 9 pages test for artificial intelligence. It provides a “clean and novel test for intelligence [and] neatly sidesteps the vast philosophical quagmire of the mind-body problem” (French, 1990, p. 53). Once a machine passes the Turing Test, it implies that it possesses intelligence equivalent to that of humans. It would be the biggest breakthrough of computer science and programming. Why is the test difficult to pass? No machine has really passed the

Why Is It Difficult To Define An Aboriginal Person?

1413 words - 6 pages ). Historical circumstances have created an unbalanced dichotomy of Aboriginal identity: what their identity means to Aboriginal people, versus what Canada, particularly the country’s policy-makers, desire them to be. This paper will outline why it is difficult to define an Aboriginal person as they are constantly faced with forcefully altered identities, definitions, and place amidst transcending political borders. The identities of Aboriginal peoples

Why Is It So Hard For Organizations To Manage Change?

846 words - 3 pages Why is it so hard for organizations to manage change?Jick (1993) defines change as "a planned or unplanned response to pressure and forces. Change is inevitable and organizations, which do not respond to change, are likely to struggle and may eventually, die. Change however can be painful and therefore needs to be managed, as the empirical evidence points to approximately 66% of major changes as failures. Fortune 500 executives claim that this

Why It Is So Important To Preserve Our Rainforests

1891 words - 8 pages of our planet” for this very reason (Kristof). The trees and plants are continually recycling carbon dioxide into fresh oxygen. Furthermore, lumber, one of the most obvious resources is plentiful in the rainforest. Without a doubt, lumber is one of the main factors contributing to deforestation, which is why we must be extra careful when it comes to using trees for their lumber. If used extremely wisely and replanted after destruction, lumber