Thestudy discovered that a higher domestic interest rate will cause realdepreciation of the IDR/U.
S dollars exchange rate whereas a higher stock pricewill lead to real appreciation and this is consistent with the postulation ofthe Mundell –Fleming model. However the study bySiklos (1988), in Canada did not empirically validate the Mundell Flemingmodel. The study was carried out using a VAR model and the results showed thatthere is no empirical link between output deficits and interest rates. Furtherstudies show that devaluation as a policy instrument in the Mundell-Flemingmodel increases net exports.
This is a postulation supported by theMarshal-Lerner theory. Further on the effect of exchange rate on the flow ofnet exports. Udomkerdmonkol et al (2006),)investigated the impact of exchange rates on the U.S FDI inflows to a sample ofsixteen emerging market countries using panel data for period 1990-2002. Theresults show that there is a negative relationship between the expectation oflocal currency depreciation and FDI inflows.
In other words, cheaper localcurrency (devaluation) attracts FDI while volatile exchange rates discourageFDI. Ullahet al (2012) studied the relationship among FDI, exchange rate and exchangerate volatility. In this study, time series data was used for foreign directinvestment, exchange rate, exchange rate volatility, trade openness andinflation, from 1981 to 2010 for Pakistan. The results squeezed from the studydemonstrate that FDI is positively associated with Rupee depreciation andexchange rate volatility deters FDI. Pandey(2013) did a work on tradeelasticities and the Marshal -Lerner condition for China. Using a multivariateco integration approach, the research found that a rise in real exchange rateboosts India?s exports as expected in theory, meaning that the Marshall- Lernercondition holds in India. Chingarade et al (2012) tried to find therelationship and impact of interest rates on FDI flows. They also sought tofind out other determinants that significantly affect FDI inflows in Zimbabwein the period February 2009-june 2011.
The research hypothesis tested that highinterest rates have a positive impact on FDI inflows. The technique of ordinaryleast squares (OLS) was used. This paper found that interest rate had nosignificant impact on FDI and hence cannot be used in making policies. Onsome literature reviewed on Nigeria, Olasunkunmi and Babatunde(2013) conducteda research on empirical analysis of fiscal policy shocks and current accountdynamics in Nigeria over the period 1980:1-2010:4. The study employed aVAR model and the results showed that an expansionary fiscalpolicy shocks has a positive effect on output, exchange rate and negativeimpacts on current account balance and interest rate and this is in line withthe postulations of the Mundell-Fleming model. Babatunde and Akinwade (2010)examines the consistency, persistency and severity of volatility in exchangerate of the Nigeria currency vis-a-vis United States dollar using monthly timeseries data from 1986- 2008. The ARCH and GARCH methodology was employed. Theresults indicated the presence of overshooting volatility shocks.
Ibrahim(2013) investigated the effects of real exchange rate misalignment on capitalinflow in Nigeria between the year 1960 and 2011. The paper computes realeffective exchange rate using IT trade partners of Nigeria. The two stage errorcorrection method developed by Engel and Granger (1989).Frederick, Amuka,Hadassah and Attamah (2014) Consideredthe constant outflow of capital and the constant trade deficit in the Nigerianeconomy, the Mundell-Fleming model provided policy prescriptions for suchunfavourable situation. However, the empirical validity of this model wastested in their work which showed the model applicability in Nigeria context.The study was carried out using data obtained from the Central Bank of Nigeria(CBN) 1981 to 2012 The technique of Vector Autoregressive Model and the Grangercausality test were used to test the empirical validity of this model inNigeria. The result of the impulse – response function using VAR showed thatthe prediction of the Mundell-Fleming theory held and its policy prescriptionscan be effective in the Nigerian economy. Based on the position of the reversedof the model adopted for this study, most of the studies reviewed for thisresearch focused on how monetary policy impact the external sector but in thisstudy, the focus will be on how monetary policy respond to shocks and maintain stabilitywhen been confronted with the vagaries of the external sector which has notbeen considered by any of the researches available at the period of study.
Thescope is also a great advantage because it captures the shocks experienced in2016 owing to the fact that the data on the fiscal year has just been madeavailable by NBS while