NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

On the Consistency of Short-run and Long-run Exchange Rate Expectations

Kenneth A. Froot, Takatoshi Ito

NBER Working Paper No. 2577 (Also Reprint No. r1360)
Issued in May 1988
NBER Program(s):   ITI   IFM

This paper examines whether short-term exchange rate expectations move "too much" by comparing them with long-term expectations. We develop a set of nonlinear restrictions linking expectations at different forecast horizons. The restrictions impose consistency, a property weaker than rationality. We use ex- change rate survey data to measure expectations and then test whether consistency holds. The data show that a current, positive exchange rate shock leads agents to expect a higher long-run future spot rate when iterating forward their short-term expectations than when thinking directly about the long run. In this sense short-horizon expectations may overreact to current exchange rate changes.

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Document Object Identifier (DOI): 10.3386/w2577

Published: Froot, Kenneth A. and Takatoshi Ito. "On the Consistency of Short-run and Long-run Exchange Rate Expectations." Journal of International Money and Finance, Vol. 8, no. 4, pp. 487-510, (December 1989).

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