The Failure of the Monetary Model of Exchange Rate Determination

31 Pages Posted: 7 Apr 2015

See all articles by Dinçer Afat

Dinçer Afat

University of Barcelona - Department of Economic Theory

Marta Gómez-Puig

Economic Theory Department. University of Barcelona

Simon Sosvilla-Rivero

UCM Institute for Economic Analysis

Date Written: March 2015

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

JEL Classification: F31, F41

Suggested Citation

Afat, Dinçer and Gómez-Puig, Marta and Sosvilla-Rivero, Simon, The Failure of the Monetary Model of Exchange Rate Determination (March 2015). Available at SSRN: https://ssrn.com/abstract=2590451 or http://dx.doi.org/10.2139/ssrn.2590451

Dinçer Afat

University of Barcelona - Department of Economic Theory ( email )

Barcelona
Spain

Marta Gómez-Puig

Economic Theory Department. University of Barcelona ( email )

Diagonal 690
Barcelona, 08034
Spain
34-93-4020113 (Phone)
34-93-4039082 (Fax)

Simon Sosvilla-Rivero (Contact Author)

UCM Institute for Economic Analysis ( email )

Carretera de Humera s/n
Madrid, Madrid 28223
Spain
+34913932626 (Phone)

HOME PAGE: http://www.ucm.es/info/ecocuan/ssr/

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