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

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