Assessing Monetary Model of Exchange Rate Determination: Case of Indonesia

Abstract

The main purpose of this paper is to assess the exchange rate determination in Indonesia after the Asian financial crisis. We use the Monetary Model to assess the prediction of the Indonesian Rupiah against the United States Dollar and other currencies of the largest trade partners of Indonesia. The models are the Flexible Price Monetary Model and the Sticky Price Monetary Model. We estimate short-run and long-run relationships using the Error Correction Model. The Monetary Model can explain partially the exchange rate variations, but the signs of money, income, and fiscal balance are not as expected. The causality may run from the exchange rate to money and price level.