We examine the influence of rapid growth in China's money supply on the US dollar within a framework of monetary models of exchange rates. We develop out-of-sample forecasts of the US dollar exchange rate using US and global data on price level, output, and interest rates, and money supply data for the US, China, and the rest of the world for the period 1996–2013. Monetary model forecasts significantly outperform a random walk forecast in terms of mean squared forecast error in the long run. A monetary error correction model with sticky prices performs best. Rolling sample analysis indicates changes over time in the influence of Chinese money supply in forecasting the US dollar. The expectation is that rapid money growth in China would increase the demand for dollars thus raising the value of the dollar, yet our forecasts are to the contrary for the mid 2000s. This is consistent with anticipation of renminbi appreciation under China’s managed exchange rate, which made holding renminbi more attractive. With the break from a dollar peg in 2005 and subsequent currency appreciation, the distortion was alleviated and the forecast direction for the dollar became as expected.

Item Type:	Refereed Article
Keywords:	China’s money supply; Forecasting US dollar,Monetary model
Research Division:	Economics
Research Group:	Applied economics
Research Field:	Financial economics
Objective Division:	Economic Framework
Objective Group:	Macroeconomics
Objective Field:	Monetary policy
UTAS Author:	Vespignani, JL (Associate Professor Joaquin Vespignani)
ID Code:	111912
Year Published:	2016
Web of Science® Times Cited:	2
Deposited By:	TSBE
Deposited On:	2016-10-14
Last Modified:	2017-10-25
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