The monetary model of exchange rate determination in the light of cointegration

This dissertation is an attempt to revive the monetary model of exchange rate determination as a long run relationship allowing for short run derivations of the exchange rate from its fundamentals. We use data on three bilateral U.S.$ exchange rates (British pound, German mark and Japanese yen) and other macroeconomic variables (money supply, industrial production, interest rate, and inflation), that traditionally enter the monetary approach to exchange rate determination. We use two econometric methodologies, Engle and Granger\u27s two-step procedure and the multivariate FIML procedure developed by Johansen. We find that there are several nontrivial cointegrating vectors linking the exchange rate and its fundamentals. These cointegrating vectors do not reflect the typically assumed symmetry restrictions. All three exchange rates are weakly exogenous with respect to the cointegrating vectors. Finally, we analyze the empirical size and power of Johansen\u27s likelihood ratio tests under deviations from normality