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The long run change in the nominal exchange rates has been decomposed into the long run inflation differential and the long run change in real exchange rate.( What Determines the Nominal Exchange Rate? Some Cross-Sectional Evidence, byPhilip R. Lane, pg5)

Factors determining the long run inflation rate

As the long run inflation rate determines the long run nominal exchange rate, it is important to know the factors determining the long run inflation rate. The long-run inflation can be modelled as the outcome of a Barro-Gordon game between the government and the public (see Barro and Gordon 1983). A key result is that the greater the incentive to inflate, the higher will be the long- run inflation. The incentive to inflate depends on the seigniorage needs of the government and the income effect generated by monetary expansion. Higher the level of outstanding nominal government debt, greater would be the incentive to inflate. Higher the real income effect of an increase in output generated by a monetary surprise, lesser would be the incentive to inflate. According to the analysis developed by Romer(1993) and Lane(1997), these factors are less important in more open and smaller economies. This suggests that the long run inflation will be lower in open and smaller economies. Finally, according to Rogoff (1985), it is well understood that appointing a central bank governor who is supposed to gain less from inflation than the government can reduce the equilibrium inflation rate.( What Determines the Nominal Exchange Rate? Some Cross-Sectional Evidence, byPhilip R. Lane, pg7)

Factors affecting the change in the long run real exchange rate

Economic growth and movement in the terms of trade are the two important factors in the determination of the long run change in the real exchange rate. Economic growth would lead to high investment rate and high export growth. High export growth leads to current account surplus. Also, economic growth leads to increasing capital inflows into the country causing an increasing demand for the currency. Hence, this leads to appreciation of the currency.

Improvement in the terms of trade leads to a higher demand for the currency, causing an appreciation of the exchange rate.

Nominal exchange rate

The equation for nominal exchange rate is the following

πEi= πzi-π*+ πR(gi,g*,πTTi )

whereπEiis the rate of nominal depreciation, zi includes all the variables affecting the rate of inflation like openness and country size, gi & g * are the growth rates of home & foreign country respectively. πTTi is the growth rate of the terms of trade.

The above equation estimates long run rate of nominal depreciation as a function of a set of variables. These include zi which are the set of variables affecting the rate of inflation including country size, openness, outstanding government debt, etc. The gr本论文由英语论文网提供整理，提供论文代写，英语论文代写，代写论文，代写英语论文，代写留学生论文，代写英文论文，留学生论文代写相关核心关键词搜索。