To summarize exchange-rate determination, theory and empirical evidence show that the dollar’s exchange rate against different currencies tends to fluctuate in the short term according to the manufacturing cycle and “flight-to-safety” considerations, and in the medium term according to deviations from purchasing power parity and relative differentials in growth and interest rates. In the long term, the short- and medium-term effects wash out, leaving inflation differentials and relative purchasing power parity to be the ultimate determinant of the dollar’s value against other currencies.
