The Exchange Rate Disconnect Puzzle Revisited

A long‐standing puzzle in the international macroeconomic literature has been the weak link between the theoretical foundations of the monetary approach to exchange rate determination and its empirical validity. This paper aims at filling this gap. We use a different econometric methodology; the Autoregressive Distributed Lag approach to cointegration, to show that exchange rates and fundamentals move together in the long‐run, thus providing support to the monetary model. We also show that fundamentals Granger cause exchange rates, both in the short‐run and the long‐run.