Earlier, factors related to changes in merchandise trade flows and the behaviour of commodity price inflation were well understood and provided guidance for operating monetary policy. In this environment, monetary policy principally targeting low inflation was consistent with exchange rate changes under purchasing power parity.
These traditional anchors of understanding have been swept away by the vicissitudes of capital movements, with currencies often moving far out of alignment of the traditional fundamentals. Moreover, it now appears that expectations and even momentary reactions to the day’s news are often more important in determining fluctuations in capital flows and hence it serves to amplify exchange rates volatility.