The monetary exchange rate model within the ERM: cointegration tests and implications concerning the German dominance hypothesis

Abstract

This paper examines whether the monetary exchange rate model represents a long-run relationship among nominal exchange rates, money supplies, interest rates and real incomes of five countries that participate in the ERM. Cointegration tests are conducted using the method suggested by Johansen and Juselius (1990). The results strongly support the hypothesis of cointegration for all ten ERM country-pairs considered. Furthermore, multiple cointegrating vectors are found for all cases. These results can be interpreted as evidence that the monetary model represents a stable long-run relationship for all ERM countries considered. Finally, the monetary model is used as a basis for testing the German dominance hypothesis. The results support this hypothesis only for one country

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