TITLE:
The INR/USD Exchange Rate Determination: An Empirical Investigation of the Flexible Price Monetary Model in a Vector Auto Regression Framework
AUTHORS:
Bhargavi Karamcheti, Vaishali Padake, T. Geetha
KEYWORDS:
Flexible Price Monetary Model, INR/USD, Exchange Rate, VAR, Variance De-composition Analysis
JOURNAL NAME:
Theoretical Economics Letters,
Vol.8 No.5,
April
19,
2018
ABSTRACT: The current study attempts to examine the importance
of the Flexible Price Monetary (FPM) Model in explaining the INR/USD exchange
rate movement with macro variables such as relative money stock, relative rates
of interest and relative output for the period from April 1995 till December
2016. Prior to estimating the empirical
model, an array of non-stationarity tests was employed to identify the time
series characteristics of the data. Since all the data series were confirmed to
be integrated of order one, the multivariate cointegration methodology was used
to verify long-run validity of the model. The empirical results garner support
for the FPM model in determining INR/USD exchange rate in the long
run. The test on direction of causality confirmed existence of causality from
FPM variables to exchange rate. The
empirical model was estimated in the Vector Auto regression (VAR) framework and variance decomposition analysis was used to examine fluctuation in
INR/USD exchange rate caused by the shocks in FPM model variables. It was found
that, the monetary model variables explain the exchange rate patterns over a
longer period of time but was found not very effective in the short run and
hence cannot be considered as a useful framework in explaining the variations
in INR/USD exchange rate.