FXStreet (Bali) - Following the release of the RBA' preferred model of the A$, Goldman Sachs provides its take, noting that it is of interest that the model's current estimate of over valuation is consistent with our 67c A$ forecast on a 6 month view. Key Quotes "Although this update on the RBA's preferred A$ model is unchanged, it is of interest that the model's current estimate of over valuation is consistent with our 67c A$ forecast on a 6 month view. It is also of interest to contrast our long standing approach to modelling the A$ to that of the RBA." "Our model showed remarkable stability throughout the estimation period which is key conclusion of the RBA paper. Where our model differs is that that we do not rely on relative interest rates to be a long run variable. Instead we followed the advice of Meese and searched for a 'deeper' parameter in the form of the 'monetary model' which neatly incorporates the theories of uncovered interest rate parity, purchasing parity and money market equilibrium in the one variable." "The virtue of this is that it provides a framework for dealing with quantitative easing strategies in major developed nations and independent interest rate hikes by banks in the Australian environment. By putting the focus on relative money supply growth and relative economic growth it in essence captures the relative success of quantitative easing strategies to the extent they result in an expansion in system credit and the extent that this expansion boosts productive activity." "In contrast, the RBA has attempted to capture the impact of unconventional monetary policy via focusing on long bond yield differential, despite the strong co-movement in Australian and G3 real bond yields." "Our final long run variable was the accumulation of unhedged capital flows (portfolio debt flows plus Eurobond net issuance plus net equity flows. This variable is consistent with the ‘portfolio balance’ theory of exchange rates neatly captures the relative importance of reserve diversification flows for global central banks verses private sector flows, a topic of particular interest at present." "Our short run variables were also different in that in addition to lagged changes in our long run variables we found a role for the speculative positioning in A$. Our model appears to have a higher explanatory power than the RBA's model, albeit the 2 models are estimated using slightly different techniques and over different time periods." "The RBA's model is perhaps more transparent and appears to generate a similar path for the real exchange rate. While we agree with the RBA that there is little point in declaring a particular model to be clearly superior to another we believe our approach has strong theoretical foundations and is better placed to tease out the important implications of unconventional monetary policy, reserve diversification and capital flows." For more information, read our latest forex news.