Exchange Rate Dynamics and Monetary Fundamentals: Evidence from South Asian Countries

This paper examined the role of monetary fundamentals in determining nominal exchange rate changes in South Asian countries. The Vector Autoregressive (VAR) technique and Autoregressive Distribution Lag (ARDL) were used. Results from the VAR indicate that the exchange rate responds to shock originating from differences in money supply, inflation differential, interest rate, and real income differential and are consistent with the short-run predictions of the monetary model of the exchange rate. The results show that inflation and interest rate differentials are responsible for the majority of changes in exchange rates in the short run. The conclusion from the result is that, particularly in the short run, monetary fundamentals are the primary causes of exchange rate fluctuations in South Asian countries.