The monetary approach to the exchange rate: empirical observations from Korea

This note re-examines the flexible-price monetary approach to the exchange rate between the Korean won and the three key currencies: the US dollar, the German mark and the Japanese yen. The note reports the important findings. First, at least one cointegrating vector exists, which indicates that an unrestricted flexible-price monetary model is a valid framework for analysing the long run exchange rate. Second, it is found that some popular monetary restrictions on this model are valid for the Korean won-German mark rate and the Korean won-Japanese yen rate: especially all variables in the model are correctly signed and mostly statistically significant for the Korean won-German mark rate.