ABSTRACT
The real exchange rate is one of the most important macroeconomic variables, and has been at the centre of policy discussions in both developed and developing economies. It is important for policy-conduct purposes to evaluate the 'appropriateness' of the real exchange rate and understand the causes of deviation of the real exchange rate from its long equilibrium. This chapter follows the strand of literature on the equilibrium real exchange rate to model empirically both the short-run and long-run dynamics of the real exchange rate for groups of developing countries. Special attention is given to the impact of capital flows on real exchange rates. The phenomenal growth of capital flows to less developed countries has been one of the most far-reaching developments in the world economy in the past two decades. While capital flows can bring to those countries much-needed resources and embedded technological transfer and managerial know-how, they frequently pose difficulties to the recipient country's macroeconomic management. Real appreciation is a major difficulty that capital flows cause (see Calvo et al., 1993; Edwards, 1998). However, no study has used disaggregated capital-flow data to investigate the effects of different types of capital flows on the real exchange rate in different countries.
