The Monetary Model – A panel data approach

Abstract The purpose of this paper is to determine if effective exchange rate pricing can be based on the (flexible) monetary model. If so, it implies a cointegration relationship with a cointegrating vector between the spot exchange rate and the non-stationary determining variables of the monetary model; relative money supplies and relative national incomes. Cointegration tests for individual countries have been done frequently and without evidence pro the monetary model. But there are some indications that the increased power achieved form a multi-country cross-setting, or panel data, show evidence in favour of the monetary model. In this paper we find evidence of at least one cointegrating relationship of the monetary model in a small panel with post Bretton-Woods observations. We also find supporting evidence related to the significance of modelling the variables determining the long-run real exchange rate equilibrium in the monetary model