On the dynamic relationship of exchange rates and monetary fundamentals: an impulse-response analysis by local projections

Meese and Rogoff (1983) first examined the dynamic relationship between exchange rates and monetary fundamentals and indicated that monetary fundamentals do not contain predictive component of exchange rates changes at short horizon. This note re-examines this relationship by estimating the local projections (Jorda, 2005) to calculate the responses of the exchange rate to monetary fundamental impulse. As a result, we confirm the dynamic relationship: Evidence from both cubic and linear projections show that monetary fundamentals contain information of future exchange rate changes.