The monetary approach to the exchange rate: long-run relationships, coefficient restrictions and temporal stability of the Greek drachma

Abstract

The monetary approach to the exchange rate is examined for four Greek drachma bilateral exchange rates, using data for the recent experience with flexible exchange rates. Four important findings are reported. First, it is demonstrated using the Johansen-Juselius multivariate cointegration technique, that an unrestricted monetary model is a valid framework for analysing the long-run equilibrium relationship of the exchange rate. Second, is found that the proportionality hypothesis of the exchange rate to relative monies is accepted for the four bilateral rates. Third, using some new tests based on recursive analysis proposed by Hansen-Johansen it is found that the dimension of the cointegration space may exhibit sample dependency, but the estimated coefficients do not display instabilities in recursive estimation. Finally, using the residual-based test for the null of cointegration newly developed by Shin, it is shown, that for the case of the drachma-Deutschemark and drachma-franc the null hypothesis is accepted, whereas for the drachma-dollar and drachma-sterling it is rejected.

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