Monetary fundamentals and rupee-U.S.$ behaviour: an Indian evidence - pre and Post liberalization

Abstract

The paper examines different forms of money demand functions and derives reduced for equations relating exchange rate with monetary and real fundamentals of two economies t currencies of which are being related. The paper tries to determine Indian Rupee-U.S. doll exchange rate for the period spanning 1971 to 2004. The study also analyses the mode separately for pre liberalization and post liberalization periods using Ordinary Least Square (OLS) in simple linear and partial adjustment frameworks. The empirical findings suppc the partial adjustment model for both the periods. But after liberalization, the naive stai form of the models has been found to perform better so far as the sign and significance oft parameters is concerned. Structural break is indicated in the exchange rate movements t breaking point being the year of liberalization -1991. The adverse sign of relative real output is because of externalization and supports grow theory of exchange rate which states that, with rise in growth rate, the income has depreciating, effect on currency. As a policy this can be matched with a choice of competitive technology which makes export of high value goods competitive so as to compensate for importisation of real output. The relative money supply and interest rate differential are significant determinants corresponding models, therefore, the study indicates that there should be monetary policy coordination between India and U.S. to stabilize the rupee-% exchange rate. The significance of inflation rate differential implies that domestically inflation rate targeting may be adopt in conjunction with other policies. Recent rise in rupee value is because of intense capital flow to stock market which has put pressure on rupee.