ABSTRACT
Interest in the determinants of long-run exchange rates has a long history. Lane (1999) explained why there is much interest on the long-run movements in exchange rates. First, explaining the long-run behavior of currencies is illuminating for those interested in tracing the evolution of the global economy.1 Second, understanding of what determines long-run changes in nominal exchange rate is potentially helpful to investors comparing expected return on medium-or long-term nominal bonds in different currencies. Third, modelling the long-run behaviour of the exchange rate is the underpinning for useful understanding of the short-run behaviour of exchange rates: it is necessary to know the long-run behaviour in order to work out whether a given exchange rate movement is a deviation from its long-run path. Finally, long-run movements in exchange rate are less prone to the ‘noise’ that is present in higher-frequency exchange rate data and hence may more easily relate to the fundamental determinants indicated by theory.
