FORECASTING EXCHANGE-RATE MOVEMENTS
FORECASTING EXCHANGE-RATE MOVEMENTS
In the previous section we looked at the general law of supply and demand, showed how governments intervene to manage exchange-rate movements, and explained how inflation and interest rates can be important determinants of exchange rates. In this section we survey data that can be monitored in order to get an idea of what will happen to exchange-rate values.
As the preceding discussion elaborates, a variety of factors influence exchange-rate movements. Managers must be able to analyze these factors in order to have a general idea of the timing, size, and direction of an exchange-rate movement. However, prediction is not a precise science, and many things can cause the best of predictions to differ significantly from reality.
For freely floating currencies, the law of supply and demand determines market value. However, very few currencies in the world are freely floating; most are managed to a certain extent, which implies that governments need to make political decisions on the value of the currency. Assuming that governments use a rational basis for managing the value of their currencies (an assumption that may not be realistic in all cases), managers can monitor some of the same indicators that they follow in order to try to predict values.
The following factors have been identified as ones that should be monitored when analysts are trying to predict an exchange-rate change or a free-market movement in rates:
1. balance-of-payments statistics,
2. interest-rate differentials,
3. inflation differentials,
4. governmental fiscal (expenditures) and monetary policies (growth in the money supply) that are important indicators of inflation,
5. the trend in exchange-rate movements,
6. an increase in the spread between official and free-exchange rates,
7. the politics of the exchange-rate change,
8. business cycles,
9. changes in international monetary reserves, and
10. governmental policies that treat symptoms rather than causes.10
Most of these factors have been discussed already in one form or another as major determinants of exchange rates. Others are fairly obvious. However, it is important to understand how balance-of-payments statistics are determined and how they can be used to help forecast exchange-rate changes.
In the previous section we looked at the general law of supply and demand, showed how governments intervene to manage exchange-rate movements, and explained how inflation and interest rates can be important determinants of exchange rates. In this section we survey data that can be monitored in order to get an idea of what will happen to exchange-rate values.
As the preceding discussion elaborates, a variety of factors influence exchange-rate movements. Managers must be able to analyze these factors in order to have a general idea of the timing, size, and direction of an exchange-rate movement. However, prediction is not a precise science, and many things can cause the best of predictions to differ significantly from reality.
For freely floating currencies, the law of supply and demand determines market value. However, very few currencies in the world are freely floating; most are managed to a certain extent, which implies that governments need to make political decisions on the value of the currency. Assuming that governments use a rational basis for managing the value of their currencies (an assumption that may not be realistic in all cases), managers can monitor some of the same indicators that they follow in order to try to predict values.
The following factors have been identified as ones that should be monitored when analysts are trying to predict an exchange-rate change or a free-market movement in rates:
1. balance-of-payments statistics,
2. interest-rate differentials,
3. inflation differentials,
4. governmental fiscal (expenditures) and monetary policies (growth in the money supply) that are important indicators of inflation,
5. the trend in exchange-rate movements,
6. an increase in the spread between official and free-exchange rates,
7. the politics of the exchange-rate change,
8. business cycles,
9. changes in international monetary reserves, and
10. governmental policies that treat symptoms rather than causes.10
Most of these factors have been discussed already in one form or another as major determinants of exchange rates. Others are fairly obvious. However, it is important to understand how balance-of-payments statistics are determined and how they can be used to help forecast exchange-rate changes.
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