Exchange Rate Determination

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This study examines the long-run relationship between Pak-rupee vis-à-vis US-dollar exchange rate, relative money supplies, real income, nominal interest rates, and real exchange rate over the period 1982Q2 to 2005Q4. The presence of cointegration between exchange rate, monetary fundamentals and relative real prices implies that monetary fundamentals and real factors play a significant role in determining the exchange rate. The results also ssuggestthat monetary fundamentals are still important in determining the exchange rate dynamics. Furthermore, during the reforms period the results of the monetary model appear to be highly consistent with the predictions of monetary model and short-run behaviour of monetary fundamentals is highly responsive. Based on the empirical findings, we derived two main conclusions: the monetary approach to exchange rate is still a valid representation in the determination of long-run exchange rates behaviour. Second, besides the monetary factors, real factors play a significant role in the determination of exchange rate in Pakistan.