Question

Outline the ‘news’ model of exchange rate determination. What explanations are there for its apparent failure to explain empirically the variability of exchange rates?

Answer 1

The news model of exchange rate determination is based on the premise that people observe the news that gives them forecast on the level of exchange rates in teh economy and speculate on what the exchange rate will be thereby affecting the exchange rate now through their guided exports and/or imports.

The news influences the purchasing power parity. Since financial assets affect the exchange rate of curenncy in the economy, News on the stock exchange markets, Any informaiton by central bank son money supply will aslo affect them.Any new information quickly affect the people's perception of exchange rate and hence is said to affect the exchange rate itself. One has to note that news affect exchange rate fluctuations more and are short lived than prices of goods and services, because of the liquidity of the rates. A currency is more liquid than a physical good.

But the flaw in this theory, or any theory for that matter,is that the future is unpredictable. Real world is full of surprises and shocks. The accuracy of the theory is in question since the events that caused it are unforeseen.And it is rather difficult to arrive at a specific cause as the fluctuations are more general and shortlived. Meaning you cant pin poitn a specific population and say they are the reason for the change.