This study has been prepared mainly by G Hacche and J C Townend of the Bank's Economics Division.
Given that econometric attempts to explain exchange rate movements have been notably unsuccessful, it adopts an alternative approach. It was hoped that careful inspection of charts of exchange rate movements and of factors likely to have influenced them might be more illuminating-possibly even providing insights which could later be tested more rigorously. Changes in the value of sterling or any other major currency are looked at, not in isolation, but in the context of currency movements generally-since exchange rates are by definition interrelated, and there may be common influences.
Some findings are:
- Movements in exchange rates have not been closely related to changes in relative price levels in the short run, so they have fluctuated widely in real as well as in nominal terms. Moreover, purchasing power parities may not hold over longer periods.
- Changes in preferences for different currencies may have contributed to exchange rate movements, as may shifts in global wealth between countries whose preferences differ-in particular, shifts associated with current account imbalances induced by oil price changes.
- Current account developments may also frequently have been influential through their impact on expectations.
- Relative interest rate movements have also been associated with exchange rate fluctuations-but not in any obviously stable way.
These results may help to suggest why econometric models of exchange rate behaviour have not been successful.