Is the Monetary Model Useful in Explaining Exchange Rates? - Panel Cointegration Evidence

Abstract

A number of studies have sought to provide a reasonable explanation for exchange rate determination. The most frequently used approach is based on monetary models. However, it is difficult to find a cointegration relationship between exchange rates and relative differentials of money and income using this approach. This does not mean that a cointegration relationship does not exist. Conventional single equation approaches simply have a low performance power. We employed the panel cointegration approach to overcome this potential problem. We formulated a system of monetary models for 8 nations and found that cointegration relationships existed. Given these cointegration relationships, we estimated cointegrating vectors that are consistent with theoretical signs and magnitude.