Modelling the floating Australian dollar: Can the random walk be encompassed by a model using a permanent decomposition of money and output?

This paper tests whether the Australian dollar has, at least, followed a random walk with drift in the first two years of its float. Having established this benchmark, structural monetary models are constructed to see whether one can obtain better within-sample and/or out-of-sample results. Rational forecasts of exogenous variables are obtained using Muth's (1960) decomposition; interpolation is used to obtain weekly forecasts when the observation period is greater. It appears that the random walk can be beaten.