The Failure of Empirical Exchange Rate Models - Essay Example

? The failure of empirical exchange rate models: no longer new, but still true Summary This is an article about the failure of empirical exchange rate models and the reasons behind it. The writer opened up his arguments by saying that G3 exchange rates are resistant to the systemic empirical explanations. Then he added the fact that interest rates rebirth is also helping in determining of the exchange rates. Exchange rate modeling in the early 1970 was then interestingly explained by Kenneth, he told about his early days at Federal Reserve Board in Washington. According to Kenneth, new chairman helped the brokers by transition to the flexible exchange rates. At that time no one really understood the importance of that step by the chairman. The exchange rate forecast group of FRB didn’t want to disclose their forecasting method to the world. Kenneth and Meese was given the task to see that whether there is any forecasting model that can give systemic values of exchange rates (forecasted ones). Volatile nature of the exchange rate at that time was seemed to be explained by the “asset approach to the exchange rate” by Mussa, Frenkel, Dornbusch and others. According to this theory, exchange rates were not only dependent on the demand and supply for imports and exports but also dependent on other things like money supply and outputs. According to writer this theory was interesting because at that time it seemed to explain the reason for the volatile nature of the exchange rates. Then it has explained the thoughts of Jacobs about the volatile nature of the monetary policy and its misunderstanding associated with the oil price shock. Frenkel further argued that the present changes in the exchange rates are the indication of the changes coming in the future. This article further elaborates the Dornbusch’s notion about the goods prices to be “sticky”. The writer then explained the limitations, conducting the study, they were facing. According to Kenneth, the only ray of optimism for the two researchers was that the bit of early work on the empirical models was available for them to see and work on. Then he added references of those studies in his article to solidify his point. The writer then explained the fact that he with Meese wanted to predict the exchange rates in addition to explaining the fact that why these changes actually occurred. He said that they were expecting some kind of favor from their organization about retrieving the information but being juniors didn’t get it. The only option they were left with was using the auto regression model for fundamentals at that time. Kenneth then highlighted the fact that their research turned into the new direction unexpectedly. They based their research on the rolling regression model but they were also aware of the fact that the true rolling regression is impossible because of the continuous revision of the data of real variables. Knowing this fact they immediately switch from the VAR forecasts to the actual realized values of variables. The baseline was the random walk model for this forecasting, according to the Kenneth. After running thousands of regressions they came to the point that there findings were robust to the data set and other specifications defined. Moreover their findings were rejected by the others very harshly. In the closing notes of the article the writer explained the reasons for the failure of their work and placed them into two categories i.e. the link between the variables (prices and exchange rates) was not very instantaneous. Second reason he explained was the lack of connection between exchange rates and fundamentals. Arguments on the Methodology or Approach The writer from the very beginning was negative towards his own research work. In the opening lines he created the false image about this own work in front of the readers. He then explained his earlier days at Federal Revenue Board and referred to the decision of the chairman in order to explain the baseline for his study which is interesting way to communicate. Later on he explained the asset approach to exchange rate in order to educate the reader about the facts he want to teach them for understanding exchange rate rate phenomenon that is again good piece of writing. He just merely touched the Frenkel and Dornbusch point of views about the volatile nature of the exchange rates. In my opinion he should have added more elaborations of this point for his readers to understand because sometimes the intellect of the reader is not as high as that of the writer. The only limitation in conducting the study pointed out by the writer, was the limited amount of data availability initially and at different other points he explained the things like they were unable to access the high profile data of the organization and the things like that. In my point of view the writer should summarize all these things under the same heading so that again it will be very easy for the reader to get the point what he was trying to deliver. They made another mistake in my opinion when they extend their area of research without having much information and data access about it i.e. initially they were trying to find out the why the exchange rate movement occurs. Suddenly they started working on the ways to predict these exchange rates as well. This distracted them big time from the main issue and they lost the point of concentration which ultimately resulted in the failure. The other big mistake that they did was using the auto regression model for forecasting these exchange rates. This is the mistake because they were aware of the fact that the data about the real variables keep on revising very quickly. This also added to their problem in the end. In the end they became the victim of escalation of commitment, i.e. they came to know that they were coming in the wrong direction but they keep pouring in their energy and time in fulfilling the fool’s dream. Moreover, when the other researcher told them that they have done something seriously harming for the subject of economics, they should at that point immediately packed up their bags and ended up the research which they didn’t. This resulted in the wastage of time not for the organization but also their as well. In the end writer should explained the reasons for the failure of their research work in detail which he was failed to do. In merely few lines he tried to explain his failure of twenty years of work and efforts. Conclusion This report explained very briefly about the article “The failure of empirical exchange rate models: no longer new, but still true”. It has initially summarized the whole article of Kenneth in two pages in order to give quick understanding about the article to the reader. In the end it has elaborated the loopholes in the article. The constructive criticism has been made on the writing and research methodology of the researcher in order to help reader to understand what else could be done. This report is very effective to get instant and correct idea about the failure of the empirical model in forecasting the exchange rates. Bibliography Rogoff, Kenneth. "The Failure of Empirical Exchange Rate Models: No Longer New, but Still True." Economic Policy Web Essay No.1, Oct. 2011. Web. 28 Sept. 2012. . Read More