Abstract:
This paper investigates the ability of the Dornbusch (1976) sticky-price model for the
nominal metical-rand exchange rate, over the period 1994:1-2005:4 in explaining the
exchange rate movements of Mozambique. Based on the model, we find that there is a stable
relationship between the exchange rate and the fundamentals. Gross domestic product and
inflation differentials between Mozambique and South Africa play the major roles in
explaining the metical-rand exchange rate. However, when the Dornbusch (1976) model is
re-estimated over the period of 1994:1-2003:4, and the out-of-sample forecast errors are
compared with the atheoretical, Classical and Bayesian variants, of the Vector
Autoregressive (VAR) and Vector Error Correction (VEC) models, and models capturing
alternative forms of the Efficient Market Hypothesis(EMH) of exchange rates, the sticky-price
model performs way poorer. Overall, the Bayesian VEC models (BVECMs), with relatively
tight priors, are best suited for forecasting the metical-rand exchange rate.
