Models of Exchange Rate Behavior

Abstract

Since the industrial countries adopted floating exchange rate systems in early 1973, nominal and real exchange rates of the main industrial countries have grearty varied. Greater variability in the exchange rates have greatly affected the economies of industrial nations and the rest of the world. Consequently, the behaviors of exchange rates of major currencies and the U.S. dollar in particular have become focal points of many international economic policy issues in the 1980s. In consequence, many detailed studies have addressed the exchange rate behaviors and determination. However, many theoretical models of exchange rate determination yield poor explanation of the actual behaviors of the exchange rates in the 1980s. The use of such models to analyze issues of economic policy involves some embarrassment and reflects an element of faith rather than economic logic. As part of the effort to enhance our understanding of the actual movements of exchange rates under the floating exchange rate system, the purpose of this paper is to review the development of major exchange rate modeling in the past two decades and to build a better empirical model of exchange rate determination. This paper presents an empirical model of yendollar and mark-dollar exchange rates tested over the period from January 1976 to June 1990. In section one, we will discuss major theories on exchange rate determination for industrial countries generated since the early 1970s to cast some light on exchange rate modeling. In section two, we discuss some of the empirical results on the theories of exchange rate determination applied to yendollar and mark-dollar. Section three concludes this paper.