The Monetary Model of Exchange Rates and Cointegration

This monograph is the result of merging parts of the authors's doctoral dissertations presented at The University of Pennsylvania in the spring of 1991. We would like to thank the members of our dissertation committees, Francis X. Diebold, Roberto S. Mariano and Marc Nerlove for their guidance and helpful comments. We received very good comments from Albert Ando, Yin-Wong Cheung, William English, S0ren Johansen, W. Krelle, Bruce Mizrach and seminar participants at the University of Pennsylvania and the XV Simposio de Analisis Econ6mico in Barcelona. Our thanks also to Werner A. MUller of Springer-Verlag for his help. Of course, any remaining errors are ours. We are indebted to Departamento de Trabajo del Gobierno Vasco and the Department of Economics at the University of Pennsylvania for financial support through our graduate studies. The research underlying this work was partially supported by two Alfred P. Sloan Foundation Fellowships. We could not have written this monograph without the support received from our families. Sections wi thin chapters are numbered using roman numerals. References to equations within the same chapter are of the form (11.7 ) whereas if they correspond to different chapters are (2.1V.4). TABLE OF CONTENTS CHAPTER 1. Introduction 1 CHAPTER 2. The Monetary Model of Exchange Rate Determination. I. Introduction...7 II. Monetary Models ...8 III. The Asset Market View 13 IV. Empirical Evidence 15 V. Treatment of Nonstationary Variables 16 CHAPTER 3. Long Run Exchange Rate Determination I.