Flexible Exchange Rates, Prices, and the Role of "News": Lessons from the 1970s

Abstract

This paper analyzes the key issues and lessons from the experience with flexible exchange rates during the 1970s. It analyzes the efficiency of the foreign-exchange market and the volatility of exchange rates, as well as the relationships between exchange rates and interest rates. A key distinction is made between anticipated and unanticipated events, and it is shown that the key factor affecting exchange rates has been "news." The analysis then proceeds to analyze the relationship between exchange rates and prices. The deviations from purchasing power parities are being interpreted in terms of the modern asset-market approach to the exchange rate.