The Dollar/Pound Exchange Rate in the 1920s: An Empirical Investigation.

We re-examine the empirical evidence on the Dollar/Pound exchange rate in the 1920s using the simple monetary exchange rate model popularized by Bilson [ 1; 2] and Frenket [8; 9]. Thus, it is not the purpose of this paper to suggest new empirical monetary exchange rate models. Nevertheless, there are several important reasons why we re-examine the simple monetary exchange rate model. First, several important implications of the monetary exchange rate model, in our opinion, are not adequately tested in existing work. Second, there is a presumption that the failure of the monetary exchange rate model in the 1970s and the 1980s is due to special events such as real shocks that affected PPP and the instability of the U.S. money demand function. By using the data from the 1920s, we hope to avoid the problem of the instability of the U.S. money demand equation in the 1970s. Moreover, Frenkel [10] found that PPP held up reasonably well in this period. Thus, the period of the 1920s provides a favorable setting to test the monetary approach. Finally, we choose the Dollar/Pound exchange rate based on data availability. This estimation method allows us to test several cross-equations restrictions implied by the monetary approach; but, to our knowledge, have not been adequately tested before in the literature. Thus, we believe our estimation method provides a more satisfactory and stringent test of the monetary approach than using ordinary least-squares, or the Theil-Goldberger mixed estimation procedure which was criticized by Hoffman and Schlagenhauf [16] as essentially constraining the parameter values to those suggested by the theory. We tested several restrictions implied by the simple monetary model of exchange rate determination which have seldom been directly tested before. Thus, we believe our testing procedure provides a more stringent test of the monetary model of exchange rate determination than using the ordinary least-squares or the Theil-Goldberger mixed... [ABSTRACT FROM AUTHOR]