This study describes a simple model for predicting the real U.S. exchange rate. Starting with a large number of error-correction models, the authors choose the one giving the best out-of-sample forecasts over the period 1992Q3–2002Q1. In the selected model, the effective real exchange rate is cointegrated with relative productivity and the real price of oil. The short-term dynamics depend upon the evolution of the difference in GDP growth rates, the first difference of the ratio of net foreign

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... ssets to GDP, the real interest rate differential, and shocks that have a temporary effect on the real price of oil and relative productivity. Out-of-sample forecasts reveal that the model generates mean-squared errors that are systematically and statistically much lower than those from a random-walk or an autoregressive model. This result is largely due to the great stability of the parameters of the cointegration relationship.