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A Fundamental Connection: Exchange Rates and Macroeconomic Expectations

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Abstract

This paper presents new stylized facts about exchange rates and their relationship with macroeconomic fundamentals. We show that macroeconomic surprises explain a large majority of the variation in nominal exchange rate changes at a quarterly frequency. Using a novel present value decomposition of exchange rate changes that is disciplined with survey forecast data, we show that macroeconomic surprises are also a very important driver of the currency risk premium component and explain about half of its variation. These surprises have even greater explanatory power during economic downturns and periods of financial uncertainty.

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  • Vania Stavrakeva & Jenny Tang, 2020. "A Fundamental Connection: Exchange Rates and Macroeconomic Expectations," Working Papers 20-20, Federal Reserve Bank of Boston.
    • Handle: RePEc:fip:fedbwp:89607
    DOI: 10.29412/res.wp.2020.20
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    Cited by:

    1. Ryan Chahrour & Vito Cormun & Pierre De Leo & Pablo Guerron-Quintana & Rosen Valchev, 2021. "Exchange Rate Disconnect Revisited," Boston College Working Papers in Economics 1041, Boston College Department of Economics, revised 12 May 2023.
    2. Granziera, Eleonora & Sihvonen, Markus, 2024. "Bonds, currencies and expectational errors," Journal of Economic Dynamics and Control, Elsevier, vol. 158(C).
    3. Emilian DOBRESCU, 2022. "Macroeconomic Measurement of Expectations versus Reality," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(3), pages 5-30, October.

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    More about this item

    Keywords

    exchange rates; exchange rate disconnect; macroeconomic announcements; international finance; professional forecasts;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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