Identify the longrun determinants of exchange rates and the

Identify the long-run determinants of exchange rates and the short-run determinants of exchange rates. In a free market, what determines exchange rates in the long-run and the short-run?

Solution

The long run determinants of exchange are preferences of the consumers for domestic and foreign goods, trade policies of the government and productivity levels in the country.

The short run determinant of the exchange rate are domestic interest rate, foreign interest rate and expected future spot exchange rate.

In a free market, the exchange rate is determined by levels of trade with other country, differentials in the inflation level, differential in the exchange rate, public debt of the country and political and economic stability of the country.