Chapter Introduction We have so far considered the exchange rate literature from a predominately theoretical viewpoint, but the exchange rate field has also been rich in empirical research. Apart from investigations into the validity of PPP theory which we examined in Chapter 6, empirical research on exchange rates has addressed three other key questions:
1) Is the foreign exchange market efficient? 2) What model best predicts exchange rate movements? 3) How can we model exchange market participants’ expectations?
Answers to these questions are of enormous importance from a policy viewpoint. If it can be shown that the foreign exchange market is ‘efficient’ then the case for government intervention in that market would be considerably undermined. While if we can identify a model that successfully explains exchange rate determination, it would be possible for the authorities to determine the best way to influence exchange rates and limit exchange rate volatility. Furthermore, the consequences of alternative economic policy measures could be better evaluated as their implications for the exchange rate would be understood. Finally, if we understood how exchange market participants form their views on exchange rates, then policy-makers may be able to use such information to help them in the process of stabilizing those rates.
