Currency and Competitiveness in Europe
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Currency and Competitiveness in Europe

Edited by Klaus Liebscher, Josef Christl, Peter Mooslechner and Doris Ritzberger-Grünwald

This book combines currency matters with competitiveness considerations, with a view to raising the understanding of exchange rate dynamics and to analysing the role of exchange rates in reinforcing economic competitiveness.
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Chapter 6: Fundamentally Lost? On the Role of Fundamentals in Exchange Rate Economics in History and Theory

Peter Mooslechner


Peter Mooslechner1 Foreign exchange markets behave more like the unstable and irrational asset markets described by Keynes than the efficient markets described by modern finance theory. (Krugman, 1989) One of the key features of exchange rates when they are flexible is that they tend to be highly volatile. (MacDonald, 2007) 6.1 INTRODUCTION The exchange rate is a strange and rather complicated animal. The difficulties already start with the method of quotation: most people – even those trained (to some extent) in economics – tend to be confused by the fact that a rise in the EUR/USD rate means a depreciation of the euro, and vice versa. A second complicated issue with exchange rates is the fact that they are (almost) the only directly observable relative prices, whereas people are used to dealing with prices of goods and services in absolute money terms in all other areas of economic behaviour. Other puzzles include questions like the random-walk characteristics of exchange rate movements as well as their speculative nature, which, on many occasions, drives exchange rates away from what is called ‘fundamental value’ – even if the precise nature of the relevant fundamental factors remains fundamentally unclear. Obviously, the exchange rate is one of the most important links – if not the key link – between a country’s domestic economy and the surrounding world. In particular in the small open economy case (SMOPEC) and given the less than fully flexible nature of domestic prices, the nominal exchange rate is key to determining the real exchange...

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