Reexamining the monetary approach to the exchange rate: The dollar-franc, 1976-90

Using data on the dollar-franc, we reexamine the monetary model of exchange-rate determination in two ways. First, we test its validity as a long-run exchange rate model, using multivariate cointegration techniques. Second, we examine and test the model in its short-run, forward-looking, rational-expectations formulation. We argue that previous tests of the short-run model may have been incorrectly implemented. Using a variant of the Campbell-Shiller technique for testing present-value models, we demonstrate that the static monetary equation has some long-run validity; that, assuming monetary exchange-rate fundamentals, the speculative-bubbles hypothesis is rejected; but that the forward-looking rational expectations restrictions are resoundingly also rejected.