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The failure of the monetary model of exchange rate determination

Dinçer Afat, Marta Gómez-Puig () and Simon Sosvilla-Rivero ()

No 15-05, Working Papers from Asociación Española de Economía y Finanzas Internacionales

Abstract: In this paper, 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.

Keywords: exchange rate; flexible price monetary model; forward-looking monetary model; real interest differential model; money demand; purchasing power parity (search for similar items in EconPapers)
JEL-codes: F31 F41 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2015-05
New Economics Papers: this item is included in nep-cba, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3) Track citations by RSS feed

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