What Determines the Nominal Exchange Rate? Some Cross-Sectional Evidence

This paper examines the determination of long-run movements in nominal exchange rates across countries. We model the long-run movement in the nominal exchange rate as depending on (i) the long-run inflation differential; and (ii) the long-run change in the real exchange rate. We argue that the former depends on country characteristics such as openness, country size, the level of outstanding government debt and central bank independence and the latter on the rate of economic growth and the terms of trade. Empirical support for both channels is provided, suggesting the fruitfulness for the analysis of exchange rates of studying cross-sectional cross-country data.