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Myths and Misconceptions of Exchange Rates

Author

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  • Jocelyn Horne

    (Department of Economics, Macquarie University)

Abstract

This paper examines and dissects ten popular "suspect" conjectures about exchange rates. The conjectures are the following: (1) Economists know what determines the exchange rate (2) Flexible exchange rates are unstable due to destabilising speculation (3) Flexible exchange rates are excessively volatile (4) The foreign exchange market is efficient (5) Purchasing Power Parity holds (6) There is no risk in foreign exchange (7) Volatile exchange rates are harmful to trade (8) Depreciating exchange rates trigger a "vicious" inflationary circle (9) Countries with current account deficits have depreciating exchange rates and (10) Low exchange rate pass-through provides a "free lunch". The main message is that there is weak or no theoretical or empirical support for the majority of the conjectures (myths 3, 4, 6, 7, 8 and 9). Only one proposition, relative PPP, has strong empirical support but its policy relevance is weakened by the difficulty of interpreting departures from PPP. The remaining group for which there is inconclusive support presents the greatest challenge to research and policy as it includes conjecture (1).

Suggested Citation

  • Jocelyn Horne, 2001. "Myths and Misconceptions of Exchange Rates," Research Papers 0105, Macquarie University, Department of Economics.
    • Handle: RePEc:mac:wpaper:0105
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    File URL: http://www.econ.mq.edu.au/research/2001/5-2001Horne.PDF
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    More about this item

    Keywords

    exchange rates; international monetary reform;

    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation

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