The Monetary Exchange Rate Model as a Long-Run Phenomenon

Abstract

Pure time series-based tests fail to find empirical support for monetary exchange rate models. In this paper we apply pooled time series estimation on a forward-looking monetary model, resulting in parameter estimates which are in compliance with the underlying theory. Based on a panel version of the Engle and Granger [Engle, R.F., Granger C.W.J., 1987. Co-integration and error correction: representation, estimation and testing, Econometrica 55, 251-276] two-step procedure we find that the residuals of the panel-based estimated monetary model are stationary. This indicates that on a pooled time series level there is cointegration between the exchange rate and the macroeconomic fundamentals of this monetary model.

Keywords: monetary exchange rate models, nominal exchange rates, cointegration, panel data

JEL Classification: C23, F30, G15