This study tests the validity of the exchange rate disconnect puzzle in developing countries by
using the flexible price monetary model and the sticky price monetary model of the exchange
rate by employing the static and the panel data estimation techniques. The sample of the study
consists of 84 developing countries and covers the time period from 1991 to 2016. The findings
of the flexible price monetary model of the exchange rate by using the static and dynamic panel
data estimation techniques reveal that the exchange rate disconnect puzzle does not hold in developing
countries as all the variables appear statistically significant contributors of the exchange
rate. In contrast, the static and dynamic panel data estimations of the sticky price
monetary model of the exchange rate suggest that the exchange rate disconnect puzzle partially
holds in developing countries. The robustness of the results is also checked by dividing the
whole sample into three categories: low-income countries, middle-income countries and uppermiddle-
income countries. The robustness check also supported our previous findings that the
flexible price monetary model of exchange can better explain the exchange rate movements as
compared to the sticky price monetary model of the exchange rate in the context of low, middle
and upper-middle-income countries.
Keywords: Exchange Rate, Monetary Policy, Interest Rate.
