|There are a wide variety of monetary models of exchange rate determination, all of
which are outgrowth and extension of the basic flexible-price version pioneered by
Frenkel (1978) and Bilson (1978). The research aims to know and prove by empirical
means the flexible price monetary model is relevant and advantageous to explain
the fluctuation of exchange rate rupiah. The methodology involves testing first two
assumption of the monetary model, namely, the price arbitrage (unified goods
market) and the existence of a stable money demand function. Having these
assumption held, the estimation of fluctuation in exchange rate in 1997-2005 was
estimated using the flexible price monetary model developed for this purpose.
Estimation of fluctuation in exchange rate suggest that the actual behavior of
exchange rate in the period 1997 – 2005 is highly consistent with prediction of the
flexible price monetary model. Fluctuation in exchange rate of Indonesia was largely
explained by such variables as domestic money demand, domestic income and
expected inflation, consistent with hypothesis of the flexible price monetary model.