Why is our ability limited in using economic fundamentals to predict exchange-rate movements for short periods into the future? Why is there some success in predicting exchange rates in the long run?

What will be an ideal response?

POSSIBLE RESPONSE: Our inability to predict exchange rate movements for short time periods is mainly because expectations are important and can change unexpectedly. The effect of a change in the expected future exchange rate on the current spot rate can happen very quickly. Changes in expectations are generated by unexpected information. The inability is largely based on the importance of unpredictable news as an influence on the short term exchange rate movements. In addition, some investors may expect the recent trend in the exchange rate to continue and extrapolate this trend into the near future, creating a bandwagon that is not justified by economic fundamentals. In the long run, exchange rates have a tendency to revert back to values consistent with economic fundamentals, especially differences in product-price inflation rates. Economists can use these fundamentals to predict with a larger degree of success the long-run movements in the exchange rates.