ABSTRACT
This chapter aims to construct a real exchange rate index and to identify the major determinants of real exchange rate behaviour using a dynamic model of real exchange rate determination. It presents the general concept of the real exchange rate and describes several series of real exchange rates for Papua New Guinea (PNG). The chapter discusses the problems of constructing such indices, and offers alternative measures to overcome the problems. It provides a dynamic model of real exchange rate determination to analyse how the long-term equilibrium real exchange rate reacts to a series of real disturbances. The chapter attempts to develop a monetary model incorporating variables determining the movements of the actual real exchange rate. It also provides an empirical model of the real exchange rate using the theoretical model and examines the data sources and the different measures of variables. The basic theoretical framework has been adopted from S. Edwards' model of real exchange rate determination.
