Abstract
This paper identifies the determinants of nominal exchange rate movements in less developed countries operating the flexible exchange rate system. Factors peculiar to such countries which are believed to potently drive their nominal ex-change rates are incorporated into the resulting model. In particular, the weather, parallel market exchange rate and its associated premium as well as corrupt practices enter the model. While all four factors should play crucial roles in ex-plaining short-run variations in the exchange rate, corrupt practices may still be at work in the long-run. However, those more advanced developing countries that have succeeded in instituting a relatively more effective legal system stem-ming the tide of corruption, and, also characterized by a near absence of parallel exchange rate market, may follow the standard model of exchange rate in the literature.
Highlights
Either on its own or in terms of its linkage with the real exchange rate (RER), the nominal exchange rate represents a powerful economic policy tool as it influences resource allocation, growth of international trade and structural change
This paper identifies the determinants of nominal exchange rate movements in less developed countries operating the flexible exchange rate system
The theoretical literature on the determination of nominal exchange rate recognizes the influence of international trade and payments, speculation and hedging activities
Summary
Either on its own or in terms of its linkage with the real exchange rate (RER), the nominal exchange rate represents a powerful economic policy tool as it influences resource allocation, growth of international trade and structural change. It is about the most important relative price influencing practically all other prices. It deserves utmost attention especially, in matters of determination. The theoretical literature on the determination of nominal exchange rate recognizes the influence of international trade and payments, speculation and hedging activities. Due to the peculiar circumstance of most developing countries (being mostly agrarian and with a lax legal system for examples), some factors that enter into their exchange rate determination processes may be distinct.
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