Stability of the Relationship between Monetary Variables and Exchange Market Pressure: Empirical Evidence

Abstract

Since the early 1970s the monetary approach to the balance of payments has received increasing attention as a framework for balance of payments analysis.' This approach views exchange market pressure, which must result in changes in the balance of payments, exchange rates, or both, as being determined by an excess supply or demand for money within the various countries in the system.2 The simpler monetary-approach models focus on the balance of payments of a small country for which exchange rates are fixed. Accordingly, much of the earlier empirical testing dealt with small, highly open economies during periods of relatively fixed exchange rates. These tests typically found support for the monetary approach in that the signs and magnitudes of the estimated coefficients were consistent with hypothesized values. The monetary approach has also been tested in a number of recent studies of sterilization policy. The findings of many of these later studies run counter to the monetary theory [9, 60].3 The applicability of the monetary approach to advanced economies under managed floating, in which exchange market pressure rather than the balance of payments is the appropriate focal point, has not been as widely tested. Recent exceptions are Girton and Roper