How Well Do Monetary Fundamentals Forecast Exchange Rates in Developing Economies?

Abstract

The main objective of this study is to re-investigate the exchange rates predictability puzzle using the monetary model. It is hypothesized that the performance of exchange rate predictability is better off in countries with monetary instability. We employed bootstrap technique as proposed by Kilian (1999) to alleviate statistical inference intricacies inherent in the long horizon forecasting for three different monetary models (flexible price, sticky price and relative price) for selected developing economies. The empirical result shows the superiority of sticky price model along with the evidence of exchange rate predictability for high inflation economies.