Journal of Political Economy · 1981 · 489 citations · 0 references
Social SciencesEconomicsFinancial EconomicsInternational FinanceMonetary EconomicsExchange Rate DeterminationExchange Rate PolicyExchange RatesForeign Exchange MarketsMonetary PolicyPurchasing Power ParityAsset Market ApproachFlexible Exchange Rate SystemsFlexible Exchange RatesForeign Exchange Market Operations
Deviations from purchasing‑power parity are interpreted through a modern asset‑market framework for exchange rates. The paper investigates lessons from the 1970s experience with flexible exchange rates. The authors analyze foreign‑exchange market efficiency, exchange‑rate volatility, the relationship between rates and interest rates, and how exchange rates affect prices. They distinguish anticipated from unanticipated events, showing that “news” is the key driver of exchange‑rate movements.
This paper analyzes the key issues and lessons from the experience with flexible exchange rates during the 1970s. It analyzes the efficiency of the foreign-exchange market and the volatility of exchange rates, as well as the relationships between exchange rates and interest rates. A key distinction is made between anticipated and unanticipated events, and it is shown that the key factor affecting exchange rates has been "news." The analysis then proceeds to analyze the relationship between exchange rates and prices. The deviations from purchasing power parities are being interpreted in terms of the modern asset-market approach to the exchange rate.