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Monetary Model of exchange rate: empirical evidence from Malawi

 
Paper:ewp-mac/0407019
From:    
Date: Fri, 16 Jul 2004 10:05:25 -0500

Abstract:
In this paper, we examine the monetary model of the Malawi Kwacha – U S dollar exchange rate during the current floating exchange rate system by applying several recent developments in the econometrics of unit roots and cointegration. Several interesting and important results are found. A single cointegration equation is identified whose coefficients conform to the restriction implied by the monetary model. The short run equation indicates the following results: First, the domestic interest rate has a negative sign, which indicates that increases in the domestic interest rate lead to an appreciation of the Malawi Kwacha. Domestic money supply has a positive sign, which implies that reductions in domestic money supply lead to an appreciation of the Malawi Kwacha. These results have led to the following conclusions. First, we have demonstrated through the use of Johansen’s multivariate cointegration technique that an unrestricted monetary model does provide a valid explanation of the long-run nominal Malawi Kwacha – US dollar exchange rate, thus lending support to the interpretation of the model as describing a long run equilibrium relationship. Second, money supply can be employed as a tool to influence the exchange rate. This arises because a reduction in the nominal money supply through open market operations raises domestic rate of interest rate for given money demand in the short run. The increase in domestic interest rate results in an incipient short-term capital inflow. This causes the exchange rate to appreciate. Finally, the correct sign and significance of the foreign country interest rate signify the role of currency market liberalization and it is a justification of our choice of RSA as Malawi’s major trading partner in our model Keywords: Monetary model, Exchange Rate, Co-integration

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EconWPA began as a conversation between Bob Parks and Larry Blume on January 28, 1993. I located Paul Ginsparg's archive (then xxx.lanl.gov) and he graciously installed his software on a Sun Sparc system which was supporting the department of economics email and computation. EconWPA began accepting papers July 1, 1993 and had ftp, email, gopher and web interfaces. The web interface for submissions was engineered into existence in July 1995. A complete and catastrophic machine failure in 1999 caused the loss of EconWPA's email new paper announcment service at which time there were over 15,000 subscriptions with over 8,000 unique email addresses.

In 2005, Arts and Sciences commandeered the computing services that I had provided to the Department of Economics since 1987. Some might say that the department was sold out, others would (erroneously) claim that centralization is efficient, and still others would claim that I have few marketing skills.

I was told that I could keep operating EconWPA (as well as many other services including rfe.wustl.edu, barnett.wustl.edu, and three RePEc servers) but I would receive no support (hardware, software, or anthing else) and (as had been the case) no compensation. At that point, given the apparent low valuation of my activities by the department, and university, it made no sense for me to continue operating EconWPA or other services.

Thanks to all who have supported EconWPA in the past.

A Chinese curse states May you live in intersting times. I have. Bob Parks - Jan 2006