Parameter instability, superexogeneity, and the monetary model of the exchange rate

Parameter Instability, Superexogeneity and the Monetary Model of the Exchan ge Rate. - This paper argues that failure to test for parameter time invari ance yields misleading results. Time heterogeneity other than unit roots wi ll make the parameters of the unrestricted system unstable and statistical inference invalid. However, if the instability stems from a particular subs et of variables (superexogenous with respect to the parameters of interest) , conditioning on them results in a partial model with stable parameters, a nd standard inferential procedures can then be used. We apply this methodol ogy to test the monetary model of the exchange rate and find that both syst em and single-equation estimates. support it in the case of yen-dollar exch ange rate. JEL no. C22, C32, F30, F41.