Exchange Rate Determination

Abstract

In this chapter, we examine the question of exchange rate determination. In the first section we present some theoretical models of exchange rate determination. Many early models of exchange rate determination focused mainly on the current account of the balance of payments. The exchange rate was seen as the price which would alter if the current account was in disequilibrium. The main current account models are purchasing power parity, the elasticities approach and the absorption approach. We consider the purchasing power parity theory in this chapter. The other two are dealt with later in the book. Indeed, they are not usually seen as models of exchange rate determination, but rather current account determination. Looking at them from the point of view of exchange rate determination, they argue that the exchange rate can be seen as being influenced by the export of goods and services relative to the import of goods and services.