forecasting exchange rates rates

Wendy01

anyone know the difference between capital flows and saving/investment imbalance in forcasting exchange rates?

They both refer to an increase in FDI, the only difference I find is that the saving/investment theory keeps domestic savings at a level rate and is more of a backward looking theory rather than a forecasting technique.

anyone else with more insight on this?

bodhisattva

Ok, the capital flow theory says that as long as investors expect good investment opportunities in a country, capital will be flowing in and the currency will strengthen. This implies that the currency might actually continue to rise even when rates are going down, as long as the growth expectations are still alive.

The investment-savings theory is similar but reverses the causality as far as the exchange rate is concerned- a country grows rapidly, but in lack of domestic savings, investments to fuel this growth will have to be financed from abroad (this is essentially the situation the US has been for ages). In order to sustain high growth rates, the country will NEED to attract a continuous stream of foreign capital and this requires that there is a prospect for stronger currency valuations (or at least no massive depreciation). The two are very similar, but remember that under the savings-investment imbalance theory it's all about money having to come in, rather than it just coming in.

mp3bu

My way to understand difference is example of filling soda in a cup. When soda is poured, first few seconds level is higher, then level goes down slightly as froth subsides.

Same way, say economy A is expanding, capital is attracted, currency A rises above equilibrium level (established by Capital flows method). During that time imports become cheaper and so exceeds exports so current a/c becomes deficit to balance Capital a/c surplus. Once it balances, imports reduces and currency A retreats to equilibrium level. This explanation is Savings-Investment Imbalance approach.