Theories of Exchange Rate Determination



One of the key questions confronting international investors concerns what moves exchange rates? In this chapter, we look at a variety of alternative exchange rate theories. Firstly, we look at purchasing power parity (PPP) theory which has been advocated as a satisfactory model of exchange rate determination in its own right. Having looked at PPP theory, we proceed to examine how well-suited this theory is to explaining actual exchange rate behaviour since the adoption of generalized floating in 1973. As we shall see, PPP theory does not provide an adequate explanation of some of the observed features of floating exchange rates. Some possible explanations for the failure of PPP to hold are then discussed.


Exchange Rate Money Supply Purchasing Power Parity Monetary Model Domestic Interest Rate 
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Further reading

  1. Pilbeam, K.S. (2006) International Finance Palgrave Macmillan.Google Scholar
  2. Rosenberg, M. (2003) Exchange Rate Determination: Models and Strategies for Exchange Rate Forecasting McGraw-Hill.Google Scholar
  3. Sarno, L. and Taylor, M.P. (2002) The Economics of Exchange Rates Cambridge University Press.Google Scholar

Chapter 12: Theories of Exchange Rate Determination

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  9. Officer, L. (1976). ‘The Purchasing Power Parity Theory of Exchange Rates: A Review Article’, IMF Staff Papers, 23, pp. 1–61.CrossRefGoogle Scholar

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© Keith Pilbeam 2005

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