Determining Real Exchange Rates

The paper re-examines the determinants of the real exchange rate equation, and suggests alternative determinants where appropriate, as well as improvements in proxies from those conventionally used. The paper emphasises the weaknesses of the multicountry approach to empirical study of the real exchange rate. While real exchange rates are determined for Pakistan, the terms-of-trade variable is found to be insignificant. Excess demand for domestic credit, capital flow, and the “opinions” variable are all found to be inversely related to the RER. Thus government expenditure on non-tradable is positively related; and better specification of the technological change variable shows support for the balance effect.