Monetary exchange rate model as a long-run phenomenon: evidence from Nigeria

Adawo, Monday A. and Effiong, Ekpeno L. (2013): Monetary exchange rate model as a long-run phenomenon: evidence from Nigeria.

Abstract

How well does the monetary exchange rate model explain exchange rate behaviour in Nigeria? Using the Johansen -Juselius (1990) and Johansen (1991) cointegration technique, this paper examines the long-run validity of the monetary exchange rate model in Nigeria for the flexible exchange rate regime with quarterly data covering the period 1987 to 2008. We found a unique long-run relationship between the nominal exchange rate and the traditional monetary fundamentals (money supply, output and interest rate differentials). The estimated cointegrating coefficients are theoretically consistent with the monetary model and statistically significant exception of the output differential. In particular, this evidence supports strongly the validity of the monetary exchange rate model for Nigeria and also its relevance to modelling the naira-US dollar exchange rate movement.

• Item Type: MPRA Paper
• Language: English
• Keywords: Exchange rate; Monetary fundamentals; Monetary exchange rate model; Cointegration; Nigeria
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics

References

Alao, R.S., Oziegbe, T.R., Ibidapo, C.O.K. and Sharimakin, A. (2011). The flexible price monetary model of the dollar-naira exchange rate determination: a cointegration approach. British Journal of Arts and Social Sciences 7(1), 21-33.

Berben, R.P. and van Dijk, D. (1998). Does the absence of cointegration explain the typical findings in long-horizon regressions. Econometrics Institute, Erasmus University, Report 9814.

Bilson, J.F.O. (1978). Rational expectations and the exchange rate. In: Frankel, J.A., Johnson, H.G. (Eds.), The Economics of Exchange Rates. Adison-Wesley Press: MA., 75 – 96.

Chin, L., Azali, M. and Mathews, K.G.. (2007). The monetary approach to exchange rate determination for Malaysia. Applied Financial Economics Letters 3, 91–94.

Chinn, M.D. and Meese, R. A. (1995). Banking on currency forecast: how predictable is change in money. Journal of International Economics 38, 161–178.

Choudhry, Y.W. and Lawler, P. (1997). The monetary model of exchange rates: evidence from the Canadian float of the 1950s. Journal of Macroeconomics 19, 103–112.

Crespo-Cuaresma, J., Fidrmuc, J. and MacDonald, R. (2004). The monetary approach to exchange rates in the CEECs. William Davidson Institute Working Paper No. 642, University of Michigan Business School.

Cusham, D.O. (2000). The failure of the monetary exchange rate model for the Canadian – U.S. dollar. Canadian Journal of Economics, 33(3), 591–603.

Denton, F.T. (1971). Adjustment of monthly or quarterly series to annual totals: an approach based on quadratic minimization. Journal of the American Statistical Association 66, 99–102.

Dickey, D.A. and Fuller, W.A. (1979). Estimators for autoregressive time series with a unit problem. Journal of the American Statistical Association 74, 427–431.

Dornbush, R. (1976). Expectations and exchange rate dynamics. Journal of Political Economy 84, 1161-1176.

Dutt, S.D. and Ghosh, D. (2000). An empirical note on the monetary exchange rate model. Applied Economics Letters 7, 669–671.

Engle, R.F. and Granger, C.W.J. (1987). Cointegration and error correction: representation, estimation and testing. Econometrica, 55, 601-622.

Frankel, J.A. (1976). A monetary approach to the exchange rate: doctrinal aspects and empirical evidence. Scandinavian Journal of Economics 78(2), 200–224.

Groen, J.J.J. (1999). Long horizon predictability of exchange rates: is it for real? Empirical Economics 24, 451–469.

Groen, J.J.J. (2002). The monetary exchange rate model as a long-run phenomenon. Journal of International Economics 52, 299–319.

Johansen, S. (1988). Statistical analysis of cointegrating vectors. Journal Economic Dynamics and Control 12, 231-254.

Johansen, S. and Juselius, K. (1990). Maximum likelihood estimation and inference on cointegration – with applications to the demand for money. Oxford Bulletin of Economics and Statistics 52, 169-210.

Johansen, S. (1991). Estimation and hypothesis testing of cointegration vectors in Gaussian vector autoregressive models. Econometrica 59, 1551-1580.

Johansen, S. (1995). Likelihood based Inference on Cointegration in the Vector Autoregressive Model. Oxford University Press: Oxford.

Jimoh, A. (2004). The monetary approach to exchange rate determination: evidence from Nigeria. Journal of Economic Cooperation 25(2), 109 – 130.

Kouretas, G.P. (1997). Identifying linear restrictions on the monetary exchange rate model and the uncovered interest parity: cointegration evidence from the Canadian - U.S. dollar. Canadian Journal of Economics 30(4), 875–890.

Kwiatkowski, D., Phillips, P.C., Schmidt, P. and Shin, Y. (1992). Testing for the null hypothesis of stationarity against the alternative of unit roots. Journal of Econometrics 59, 1551–1580.

Lee, C., Azali, M., Zulkornain, B. and Yusuf, M.B. (2007). The monetary model of exchange rate: evidence from Philippines. Applied Economic Letters 54, 159-178.

Liew, V.K., Baharumshah, A.Z. and Puah, C. (2009). Monetary model of exchange rate for Thailand: long-run relationship and monetary restrictions. Global Economic Review 38(4), 385–395.

Lisman, J.H. and Sandee, J. (1964). Derivation of quarterly figures from annual data. Journal of the Royal Statistical Society 13(2), 87–90.

Long, D. and Samreth, S. (2008). The monetary model of exchange rate: evidence from the Philippines using ARDL approach. Economics Bulletin 6, 1-13.

MacDonald, R. and Taylor, M.P. (1991). The monetary approach to the exchange rate: long-run relationships and coefficients restrictions. Economic Letters 17, 179–185.

MacDonald, R. and Taylor, M.P. (1994). The monetary approach to the exchange rate: long-run relationships, short-run dynamics and how to beat a random walk. Journal of International Money and Finance 13(3), 276–290.

Mark, N.C.(1995). Exchange rates and fundamentals: evidence on long-horizon predictability. American Economic Review 85(1), 201–218.

Mark, N.C. and Sul, D. (2001). Nominal exchange rates and monetary fundamentals: evidence from a small post-Bretton Woods panel. Journal of International Economics 53(1), 29–52.

McNown, R.A. and Wallace, M. (1989). Cointegration tests for long-run equilibrium in the monetary exchange rate model. Economic Letters 31, 263-267.

Meese, R.A. and Rogoff, K. (1983). Empirical exchange rate models of the seventies: do they fit out of sample? Journal of International Economics 14, 3-24.

Meese, R.A. (1986). Testing for bubbles in exchange markets: a case of sparkling rates. Journal of Political Economy 94, 345-373.

Miyakoshi, T. (2000). The monetary approach to the exchange rate: empirical observations from Korea. Applied Economic Letters 7, 791-794.

Nwafor, F.C. (2006). The naira-dollar exchange rate determination: a monetary perspective. International Research Journal of Finance and Economics 5, 130–135.

Phillips, P.C.B. and Perron, P. (1988). Testing for a unit root in time series regression. Biometrika 75(2), 335–346.

Rapach, D.E. and Wohar, M.E. (2002). Testing the monetary model of exchange rate determination: new evidence from a century of data.Journal of International Economics 58, 359–385.

Sarantis, N. (1994.)The monetary exchange rate model in the long run: an empirical investigation. Weltwirtschaftliches Archives 130, 698-711.

Shylajan, C.S. and Sereejesh, S. and Suresh, K.G. (2011). Rupee-dollar exchange rate and macroeconomic fundamentals: an empirical analysis using flexible-price monetary model. Journal of International Business and Economy 12(2), 89-105.

Sims, C.A. and Stock, J.H. and Watson, M.W. (1990. Inference in linear time series models with some unit roots. Econometrica 58, 113–144.

Uz, I. and Ketenci, N. (2008). Panel analysis of the monetary approach to exchange rates: evidence from ten new EU members and Turkey. Emerging Markets Review 9, 57–69.