Determinants of the real exchange rate in the long-run for developing and emerging countries: a theoretical and empirical approach

Abstract

This paper present a new framework for the determinants of real exchange in the long-run in developing and emerging countries (DECs). We connect the model developed by Kaltenbrunner (2015), which is grounded on chapter 17 of the General Theory, with productivity's differential effect. By doing so, our frame states that even short-run factors and monetary variables affect the long-run real exchange rate. Moreover, it points out that the hierarchical nature of the international monetary system is crucial to understand exchange rate movements in DECs. Besides presenting such theoretical approach, our contribution is to test it empirically for 45 DECs from 1990 to 2008 by applying econometric techniques appropriate for panel data. We use a different dataset, which comprises, among other variables, foreign portfolio flow, interest rate differential, external vulnerability indicators and international liquidity, on annual basis. The empirical results endorses this framework. Overall, it shows the primacy of financial factors as determinants of the long-run real exchange rate, particularly new forms of external vulnerability linked to the rising share of foreign investor in domestic-currency financial assets, and points to the endogenous and self-perpetuating nature of international monetary system hierarchy.