Nominal equilibrium exchange rate models: a panel perspective

Abstract

Modeling the determinants of long-run, or equilibrium, exchange rates is currently extremely fashionable.1 In many ways this work has been inspired by recent developments in the time series literature, rather than any new theoretical interest in the determinants of long-run exchange rates. Nevertheless, this work is interesting since, in summary form, it suggests that sensible long-run relationships can be derived, particularly when the span of the data is increased from the recent floating period to a period encompassing around one hundred years of annual data.2 By sensible long-run relationships we mean, for example, when a researcher conditions an exchange rate on relative prices she finds that the exchange rate is homogeneous with respect to relative prices and that the adjustment to equilibrium, following a disturbance, takes around eight years to complete. One key problem, though, in extending the data span on an historical basis is that it may expose the investigated relationship to destabilizing regime changes. Also, for relationships which involve price indices (and indeed non-indexed variables) it is not clear how homogeneous these are over long historical periods in which the underlying basket must have changed dramatically