Testing the monetary model of exchange rate determination: new evidence from a century of data

Abstract

We test the long-run monetary model of exchange rate determination for a collection of 14 industrialized countries using data spanning the late nineteenth or early twentieth century to the late twentieth century. Interestingly, we find support for a simple form of the long-run monetary model in over half of the countries we consider. For these countries, we estimate vector error-correction models to investigate the adjustment process to the long-run monetary equilibrium. In the spirit of Meese and Rogoff [Journal of International Economics 14 (1983) 3\24], we also compare nominal exchange rate forecasts based on monetary fundamentals to those based on a naı̈ve random walk model.