The monetary model of the exchange rate: long-run relationships, short-run dynamics and how to beat a random walk

Abstract

The monetary model is re-examined for the sterling—dollar exchange rate. First, it is demonstrated, using a multivariate cointegration technique, that an unrestricted monetary model is a valid framework for analyzing the long-run exchange rate. Second, we find, once proper account has been taken of the short-run data dynamics, that an unrestricted monetary model outperforms the random walk and other models in an out-of-sample forecasting contest