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Exchange Rate Predictability

Summary:
In a Study Center Gerzensee working paper, Pinar Yesin argues that the IMF’s Equilibrium Real Exchange Rate model (ERER) helps predict medium term exchange rate changes. The reduced form equation relates the real effective exchange rate to macroeconomic fundamentals. … one of the models, namely the ERER model, outperforms not only the other two in predicting future exchange rate movements, but also the (average) IMF assessment. … the IMF assessments are better at predicting future exchange rate movements in advanced economies than in emerging market economies. Controlling for the exchange rate regime does not yield different results. … the IMF assessments have higher predictive performance in open economies than in closed economies. … safe haven currencies close the misalignment gap predicted by the models faster than other currencies. … To assess exchange rates only a modified version of the ERER model is being used since 2012. The modified versions of the MB and ES models, while still being utilized, do not have a direct link to the exchange rate anymore. That is, the IMF ceased making a direct link from equilibrium current accounts to equilibrium exchange rates for now.

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In a Study Center Gerzensee working paper, Pinar Yesin argues that the IMF’s Equilibrium Real Exchange Rate model (ERER) helps predict medium term exchange rate changes. The reduced form equation relates the real effective exchange rate to macroeconomic fundamentals.

… one of the models, namely the ERER model, outperforms not only the other two in predicting future exchange rate movements, but also the (average) IMF assessment. … the IMF assessments are better at predicting future exchange rate movements in advanced economies than in emerging market economies. Controlling for the exchange rate regime does not yield different results. … the IMF assessments have higher predictive performance in open economies than in closed economies. … safe haven currencies close the misalignment gap predicted by the models faster than other currencies.

… To assess exchange rates only a modified version of the ERER model is being used since 2012. The modified versions of the MB and ES models, while still being utilized, do not have a direct link to the exchange rate anymore. That is, the IMF ceased making a direct link from equilibrium current accounts to equilibrium exchange rates for now.

Dirk Niepelt
Dirk Niepelt is Director of the Study Center Gerzensee and Professor at the University of Bern. A research fellow at the Centre for Economic Policy Research (CEPR, London), CESifo (Munich) research network member and member of the macroeconomic committee of the Verein für Socialpolitik, he served on the board of the Swiss Society of Economics and Statistics and was an invited professor at the University of Lausanne as well as a visiting professor at the Institute for International Economic Studies (IIES) at Stockholm University.

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