exchange rate 2

International Economics at Shippensburg University EXCHANGE RATE DETERMINATION Introduction What are the factors that cause supply and demand for exchange to change? There are several theories on this topic. Some theories attempt to explain short run movements in exchange rates while others study long run movements. The determinants of equilibrium exchange rates in the short run and in the long run tend to be different. 1. Balance of Payments Approach to Exchange Rate Determination This approach …

…restrictions). Empirical evidence on PPP is also mixed. For the countries with high inflation rates (e.g., Latin America), the theory appears to perform well. However, when inflation differential is small, factor other than price comparisons can become more important in the determination of exchange rates. In addition, PPP tends to hold in the long run better than in the short run, perhaps because time lags in the BP adjustment process and government interference, etc.