The current experience of flexible exchange rates: empirical evidence for ten industrial countries

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Virginia Polytechnic Institute and State University


The theories of Purchasing Power Parity and the monetary approach to the exchange rate were empirically tested for ten industrial countries over the sample period March 1973 through June 1978.

Purchasing Power Parity (PPP) was held to represent the long-run equilibrium exchange rate, and the PPP model was designed to focus on factors affecting short-term disequilibrium such as changing interest rate differentials and foreign exchange market intervention.

The monetary model was based on the hypothesis that the equilibrium exchange rate, viewed as the relative price of two monies, is a function of the factors determining the supplies and demands for those monies.

The models were estimated using both ordinary least squares and mixed estimation. The latter method permitted the combination of sample and prior information, and in general provided improved in~ividual coefficient estimates in the presence of a highly collinear data set. Prior information was derived from the homogeneity postulate and known characteristics of the demand for money.

The empirical results broadly supported the models estimated, validity of either, yet did not strongly endorse the It was suggested that further research should be directed at improving data definition and variable specification, with particular emphasis on the measure simultaneous equations model appears to be particularly well suited to the exposition of the monetary approach.