Empirical evidence of the monetary approach to the exchange rate determinants under a fully flexible regime: the case of Mexico

Abstract
The purpose of this paper is to examine the empirical evidence on the evolution of the nominal peso-dollar exchange rate based on the monetary approach under a fully flexible exchange rate regime. We use a standardised framework where the uncovered interest rate (UIP) and the purchase power parities (PPP), flexible prices, and a typical demand for real money balances determine prices in the long run. Once we identify that time series of the nominal exchange rate and the fundamental macroeconomic variables are nonstationary, we estimate a vector error-correction model (VECM) and, for comparative purposes, an ARIMA-EGARCH model and an ARIMA-EGARCH model with monetary approach. Models' assessment based on the post estimation results shows that the model with the lowest HRMSE for all the steps-ahead forecast is the ARIMA-EGARCH model followed by the VECM model. Likewise, the lowest HMAE for the first three-steps ahead forecast is the VECM model, followed by the ARIMA-EGARCH model. Copyright © 2022 Inderscience Enterprises Ltd.