Augmented Quantity Theory of Money and Bangladesh Taka – U.S. Dollar Exchange Rate Dynamics

Abstract

This paper studies the dynamics of the Taka-U.S.Dollar exchange rate for Bangladesh by augmenting the Quantity Theory of Money. The standard cointegration methodology (Engle and Granger, 1987) is employed in addition to the ARDL (Autoregressive Distributed Lag) procedure. The ADF and KPSS tests reveal data nonstationarity, but with different orders of integration. As a result, the ARDL procedure is invoked following (Peseran et al., 2001) to search for cointegrating relationship among the variables. On the evidence of cointegration, the vector error- correction model (VECM) is estimated. The negative sign of the coefficient of the error-correction term and its statistical significance in terms of the associated t –value confirm unidirectional causal flow from broad money supply and real GDP to Taka-U.S.Dollar exchange rate and long-run convergence with short–run interactive feedback effects. Furthermore, impulse response analyses are performed for additional visual insights.