One approach to resolve the exchange rate puzzle: results using data from the United Kingdom and the United States

M Ariff, A Zarei

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Abstract

We approach a significant research topic in international economics by restating the test procedures in a novel manner consistent with monetary theorems with controls using monetary variables and applying an appropriate econometric methodology to re-examine three aspects of exchange rate behavior. (i) Does the inflation (price) factor affect Nominal Exchange Rate (NER)? (ii) Do relative interest rates between countries affect a country’s exchange rate? (iii) Do the price and interest rate effects hold if controls for non-parity factors are embedded in tests? The data series for this study are taken over 55 years covering pre-and-post-Bretton Woods era: a second test was done over the post-Bretton Woods period only using 30 years of data. Also, the traditional factors of parity conditions are extended in this research to take into account recently theorized and tested non-parity factors related to cash flows. The resulting evidence affirms clearly that both the parity factors (prices and interest rates) and the non-parity factors affect exchange rates significantly over the long run, also over the 30-year period. In our view, these findings extend our knowledge of how currency behavior is consistent with parity and non-parity theorems.
Original languageEnglish
Pages (from-to)1367-1384
Number of pages8
JournalSingapore Economic Review
Volume63
Issue number5
Early online date21 Jan 2016
DOIs
Publication statusPublished - 2018
Externally publishedYes

Bibliographical note

Electronic version of an article published as Singapore Economic Review, vol. 63, no. 5, pp. 1367-1384. https://dx.doi.org/10.1142/S0217590816500090 © copyright World Scientific Publishing Company. https://www.worldscientific.com/

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Keywords

  • Exchange rate
  • Non-parity factors
  • Prices
  • Interest rates
  • Panel cointegration
  • Dynamic OLS

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