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Excerpt from Exchange Rate Dynamics With Sticky Prices: The Deutsch Mark, 1974-1982
Finally, we do not impose the assumption that money is a random walk. This is simply false for Germany as is noted by Driskill and Sheffrin Hence the response of exchange rates and prices to monetary shocks differs from the responses considered by Dornbusch (1976) and his followers. So, we let the data inform us as to the plausible stochastic processes followed by the forcing variables we consider. Then we assume that exchange rates and prices respond optimally in that private agents are assumed to also know the stochastic processes of the forcing variables.
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