The failure of the monetary model of exchange rate determination

In this article, we test three popular versions of the monetary model (flexible price, forward-looking and real interest differential models) for the OECD member countries by applying Johansen cointegration technique. Based on country-by-country analysis, we conclude that monetary models do not prov...

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Bibliographic Details
Published in:Applied economics 2015-09, Vol.47 (43), p.4607-4629
Main Authors: Afat, Dinçer, Gómez-Puig, Marta, Sosvilla-Rivero, Simón
Format: Article
Language:English
Subjects:
Canvi
Canvi exterior
Cointegration analysis
Demand curves
Demand for money
Demand functions
Economic models
Exchange
exchange rate
Exchange rates
flexible price monetary model
Foreign exchange
forward-looking monetary model
Industrialized nations
Keynesianism
Monetary theory
money demand
OECD
Poder adquisitiu
Política de preus
Prices policy
Purchasing power
Purchasing power parity
real interest differential model
Studies
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Summary:In this article, we test three popular versions of the monetary model (flexible price, forward-looking and real interest differential models) for the OECD member countries by applying Johansen cointegration technique. Based on country-by-country analysis, we conclude that monetary models do not provide the expected results. We reveal several shortcomings of the models and examine the building blocks of the fundamental version. Although researchers always blame the deviations from purchasing power parity as the reason for the failure of the monetary model, our analysis indicates that invalidity of Keynesian money demand function is also responsible for unfavourable results.
ISSN:0003-6846
1466-4283
DOI:10.1080/00036846.2015.1031878