The Failure of the Monetary Exchange Rate Model for the Naira-Dollar

Ekong, Christopher N. and Onye, Kenneth U. (2013): The Failure of the Monetary Exchange Rate Model for the Naira-Dollar. Published in: AMERICAN JOURNAL OF SOCIAL AND MANAGEMENT SCIENCES , Vol. 4, No. 1 (2013): pp. 8-19.

Abstract

We test whether the flexible price monetary model (FPMM) of exchange rate determination is consistent with the variability of the naira-dollar exchange rates. The study account for several important issues overlooked by previous studies on the validity of FPMM including the test of long-run PPP relationship-a major building block of the monetary model, the issue inefficient estimation of cointegrating parameters, and the inconsistency of these parameters with the values implied by the monetary models. The test of long-run PPP relationship indicates that exchange rate and relative prices will apparently drift apart without bounds in the long-run, implying a failure of the long-run PPP proposition. This indicates grounds for believing the pure monetary model and its simple extensions to be misspecified as a long-run relationship and consequently suggests that it is inappropriate for forecasting purposes. We suggest a multinational model of exchange rate determination that allow for common macroeconomic effects.

• Item Type: MPRA Paper
• Language: English
• Keywords: Flexible Price, Monetary Model, naira-dollar, exchange rate, dynamic OLS
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit

References

Adler, Michael, and Leman Bruce. (1983). Deviations from the Purchasing Power Parity in the Long-run. Journal of Finance 38:48-75.

Alao, Rasheeed, Oziegbe R T, Ibidapo K O, and Sharimakin A. (2011). The Flex Price Monetary Model of the Dollar-Naira Rate Determination: A Co-integration Approach. British Journal of Arts and Social Sciences 2(1): 21-33.

Bailie, Richard, and Selover David. (1987). Cointegration and Models of Exchange Rate Determination. International Journal of Forecasting 3: 43-51.

Baillie, Richard, and Pecchenino Rowena. (1991). The Search for Equilibrium Relationship in International Finance: The case of the monetary model. Journal of International money and Finance 10: 953-966.

Berben, Robert-Paul, and Van Dijk Dick. (1998). Does the Absence of Cointegration Explain the Typical Findings in long-run regressions? Econometrics Institute, Erasmus University, Report 9814.

Berkowitz, Jeremy, and Giorgianni Lorenzo. (2001). Long-horizon Exchange Rate Predictability. Review of Economics and Statistics 83: 81-91.

Bilson, John. (1976). A Simple Long-Run Model of Exchange Rate Determination. Unpublished Manuscript, International Monetary Fund.

Bilson, John. (1978). The Monetary Approach to the Exchange Rate: Some Empirical Evidence. IMF Staff Papers 25: 48-75.

Civcir, Irfan. (2003). The Monetary Model of the Exchange Rate under High Inflation: The Case of the Turkish Lira/US Dollar. Uver/Czech Journal of Economics and Finance 53: 113-29.

Cushman, David. (2000). The failure of monetary exchange rate model for the Canadian-U.S. dollar. Canadian Journal of Economics 33(3): 591-603.

De Grauwe, Paul. (2000). Exchange Rates in Search of Fundamentals: The case of the Dollar-euro Rate. International Finance 3(3): 329 – 356.

Dickey, David, and Fuller Wayne. (1979). Distribution of the Estimators for Autoregressive Time Series with a Unit-Root. Journal of American Statistical Association 74: 112-129.

Dickey, David, Jansen Dennis, and Thornton Daniel. (1991). A Primer on Cointegration with an Application to Money and Income. Federal Reserve Bank of St. Louis Review 73:58-78.

Dornbusch, Rudiger. (1980). Exchange Rate Economics: Where Do We Stand? Brookings Papers on Economic Activity 1: 143-94.

Dornbusch, Rudiger. (1976). Expectations and Exchange Rate Dynamics. Journal of Political Economy 84: 1161-1176.

Ekong, Christopher Nyong, and Onye, Kenneth Ugwu. (2012). Economic Development in Nigeria: The Basic Needs Approach. Journal of Economics and Sustainable Development 3(10): 54-65.

Ekong, Christopher Nyong, and Onye, Kenneth Ugwu. (2012). On the Feasibility on a Common Currency in West Africa: Evidence from a Multivariate Structural VAR. Current Research Journal of Economic Theory 4(4): 120-131.

Ekpo, Hogan Akpan. (1992). Economic Development under Structural Adjustment: Evidence from Selected West African Countries. Journal of Social Development in Africa 7(1): 25-43.

Edwards, Sebastian. (1983). Floating Exchange Rates in Less-Developed Countries: A Monetary Analysis of the Peruvian Experience, 1950-54. Journal of Money, Credit and Banking 15: 73-81.

Engle, Robert, and Granger Clive. (1987). Cointegration and error correction: Representation, estimation and testing. Econometrica 55: 251-76.

Francis, Bill, Hassan Iftekhar, and Lothian James. (2001). The Monetary Approach to Exchange Rates and the Behavior of the Canadian Dollar over the Long-run. Applied Financial Economics 11: 475-81.

Frankel, Jeffrey, and Rose Andrew. (1995). Empirical Research on Nominal Exchange Rates. In Rogoff, K., & Grossman, G. (Eds.), Handbook of International Economics, North-Holland, Amsterdam 3: 1689-1729.

Frankel, Jeffrey, and Rose Andrew. (1996). A panel project on purchasing power project: Mean reversion within and between countries. Journal of International Economics 40: 209-224.

Frankel, Jeffrey. (1979). On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Rate Differentials. American Economic Review 69(4): 610-622.

Frenkel, Jacob. (1976). A Monetary Approach to the Exchange Rate: Doctrinal Aspects and Empirical Evidence. Scandinavian Journal of Economics 78:200-224.

Frenkel Jacob. (1981). Collapse of Purchasing Power Parity during the 1970s. European Economic Review 16: 145-165.

Fry, Maxwell. (1976). A Monetary Approach to Afghanistan’s Flexible Exchange Rate. Journal of Money, Credit, and Banking 8: 219-25.

Fuller, Wayne . (1976). Introduction to Statistical Times Series. New York: John Wiley & Sons.

Groen, Jan. (2000). The Monetary Exchange Rate Model as a Long-run Phenomenon. Journal of International Economics 52 (2): 299-319.

Girton, Lance, and Roper Don. (1977). A Monetary Model of Exchange Rate Pressure Applied to the Postwar Canadian Experience. American Economic Review 67: 537-548.

Gujarati, Damoder. (2004). Basic Econometrics. New Delhi: McGraw-Hill Companies Inc.

Hamilton, James. (1994). Times Series Analysis. Princeton: Princeton University Press.

Hakkio, Craig. (1984). A Re-examination of Purchasing Power Parity. Journal of International Economics 17: 265 – 277.

Hakkio, Craig, and Rush Mark. (1991). Cointegration: How short is the Long-run? Journal of International Money and Finance 10: 571-581.

Humphrey, Thomas, and Lawler Thomas. (1977). Factors Determining Exchange Rates: A Simple Model and Empirical Tests. Federal Reserve Bank of Richmond Economic Review May/June, 10-15.

IMF International Financial Statistics (CD-Rom), IMF: Washington, D.C.

Johansen, Soren. (1991). Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian vector Autoregressive Models. Econometrica 59: 1551-1580.

Johansen, Soren, and Juselius Katarina. (1990). Maximum Likelihood Estimation and Inference on Cointegration—With Applications to the Demand for Money. Oxford Bulletin for Economics and Statistics 52:169-210.

Johnson, Harry. (1972). The Monetary Approach to the Balance of Payments Theory. Journal of Financial and Quantitative Analysis, 1555-1572.

Johnson, Harry. (1976). Elasticity, Absorption, Keynesian Multiplier, Keynesian Policy and Monetary Approach to Devaluation Theory: A Simple Geometric Exposition. American Economic Review (AER) 66: 448-452.

Johnson, Harry. (1977). The Monetary Approach to the Balance of Payments: A Nontechnical Guide. Journal of International Economics 7(3): 251-268.

Mark, Nelson. (1995). Exchange Rates and Fundamentals: Evidence on Long-horizon Predictability. American Economic Review 85: 201-218.

Mark, Nelson, and Sul Donggyu. (2001). Nominal exchange rates and Monetary Fundamentals: Evidence from a Small Post-Bretton Woods Panel. Journal of International Economics 53(1): 29-52.

Meade, James. (1951). The Theory of International Economic Policy, 1: Balance of Payments, Macmillan: London.

Meese, Richard, and Rogoff Kenneth. (1983). Empirical exchange rate models of seventies: Do they fit out of sample? Journal of International Economics 14: 3-24.

McDonald, Ronald. (1988). Floating Exchange Rates: Theory and Evidence. London: Inwin-Hyman.

McNown, Robert, and Wallace Myles. (1994). Cointegration Tests of the Monetary Exchange Rate Model for Three High-Inflation Countries. Journal of Money, Credit, and Banking 26: 396-411.

McNown, Robert, and Wallace Myles. (1989a). Cointegration Tests for Long Run Equilibrium in the Monetary Exchange Rate Model. Economics Letters 31: 263-67.

Mundell, Robert. (1964). Exchange Rate Margins and Economic Policy. In J. Carter Murphy (eds), Money in the International Order, Dallas.

Mundell, Robert. (1968). International Economics. Macmillan: New York.

Mundell, Robert. (1971). Monetary Theory. Pacific Palisades, Good Years: California.

Najand, Mohammed, and Bond Charlotte. (2000). Structural Models of Exchange Rate Determination. Journal of Multinational Financial Management 10: 15-27.

Neely, Christopher, and Sarno Lucio. (2002). How Well Do Monetary Fundamentals Forecast Exchange Rates? Federal Reserve Bank of St. Louis Review 84: 51-74.

Nwafor, Ferdinand. (2006). The Naira-Dollar Exchange Rate Determination: A Monetary Perspective. International Research Journal of Finance and Economics, Issue 5.

Oh, Keun-Yeob. (1996). Purchasing Power Parity and Unit Root Tests using Panel Data. Journal of International Money and Finance 15: 405-418.

Papell, David. (1997). Searching for Stationarity: Purchasing Power Parity under the Current Float. Journal of International Economics 43: 313-332.

Pearce, Douglas. (1983). Alternative Views of Exchange Rate Determination. Federal Reserve Bank of Kansas City Economic and Financial Review, February 16-30.

Piggot, Charles, and Sweeney Richard. (1985). Testing the Exchange Rate Implications of Two Popular Monetary Models. In Arnott, S.W., Sweeney, R. J. & Willet, T. D. (eds.), Exchange rate trade and the US economy. Ballinger Publications.

Phillips. Petter, and Ouliaris Sam. (1990). Asymptotic Properties of Residual Based Tests for Cointegration. Econometrica 58(1): 65-193.

Phillips, Peter, and, Perron Pierre. (1988). Testing for Unit Root in Time Series Regression. Biometrika 75(2): 335-346.

Polak, Jacques. 1957. Monetary Analysis of Income Formation and Payments Problems. IMF Staff Papers 6: 1-50.

Ram, Padmakumar, and Prabhakar Gantasala. (2010). Determinants of Pay Satisfaction: A Study of the Hotel Industry in Jordan. European Journal of Social Sciences 14 (3).

Rapach, David, and Wohar Mark. (2002). Testing the Monetary Model of Exchange Rate Determination: New Evidence from a Century of Data. Journal of International Economics 58: 359-385.

Rapach, David, and Wohar Mark. ( 2004). Testing the Monetary Model of Exchange Rate Determination: A Closer Look at Panels. Journal of International Money and Finance 23: 867-95.

Rosenberg, Michael. (1996). Currency Forecasting. Chicago: Irwin.

Robinson, Joan. (1937). The Foreign Exchange In: Essays in the Theory of Employment, Macmillan London.

Sarantis, Nicholas. (1994). The Monetary Exchange Rate Model in the Long-run: An Empirical Investigation. Welwirtschaftliches Archiv, 130: 698-711.

Sarno, Lucio, and Taylor Mark. (2002). Economics of Exchange Rates. Cambridge University Press: Cambridge.

Stock, James., and Watson, Mark. (1993). A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems. Econometrica, 16 (4): 783-820.

Shiller, Robert, and Perron Pierre. (1985). Testing the Random Walk Hypothesis: Power Versus Frequency of Observation. Economic Letters 18: 381-386.

Taylor, Mark. (1986). Long-run Purchasing Power Parity, Mimeo. Newcastle: University of Newcastle.

Taylor, Mark, and Sarno, Lucio. (1998). The Behaviour of Exchange Rate During the Post-Bretton Woods Period. Journal of International Economics, 46 (2): 281-312.

Tinbergen, Jan. (1952). On the Theory of Economic Policy. Amsterdam: North Holland.

Van den Berg, Hendrik and, Jayanetti Sanath. (1993). A Novel Test of the Monetary Approach using Black Market Exchange Rates and the Johansen-Juselius Cointegration Method. Economics Letters 41: 413-418.

World Bank. (2012). Data Base of the World Development Indicators (WDI) and Global Development Finance (GDF), viewed on 5th October, 2012, http//:data.worldbank.org/.

Wu, Yangru. (1996). Are Real Exchange Rates Non-stationary? Evidence from Panel Data Test. Journal of Money Credit and Banking 28: 54-63.

Zortuk, Mahmut. (2009). Economic Impact of Tourism on Turkey’s Economy: Evidence from Cointegration Tests. International Research Journal of Finance and Economics (25).