The Monetary Models of Exchange-rate Determination
The purchasing power parity theory outlined in Chapter 6 is far from a satisfactory explanation of observed exchange-rate behaviour. In particular, it is very much concerned with goods arbitrage and has nothing to say about capital movements internationally. During the post-Second World War era there has been an enormous growth of capital and money markets meaning that it is possible for international investors to switch huge amounts of money out of one currency into another very speedily. This being the case, speculators will tend to move their money between currencies based on the expected rate of return of being in one currency compared to another. What people expect to happen to the exchange rate will play a crucial part in determining which currencies to buy and sell — if a currency is expected to depreciate then agents will tend to switch out of that currency into currencies that they expect to appreciate. In this chapter, we look at some more recent and sophisticated exchange-rate models that have been developed in an attempt to model exchange-rate behaviour more successfully.
Unable to display preview. Download preview PDF.
Selected Further Readings
- Bilson, J.F. O. (1978a) ‘Rational Expectations and the Exchange Rate’, in J. A. Frenkel and H. G. Johnson (eds), The Economics of Exchange Rates (Reading: Addison-Wesley).Google Scholar
- Frankel, J. A. (1979) ‘On the Mark: a Theory of Floating Exchange Rates Based on Real Interest Rate Differentials’, American Economic Review, vol. 69, pp. 610–22.Google Scholar
- Frenkel, J. A. and Johnson, H. G. (eds) (1976) The Monetary Approach to the Balance of Payments (London: Allen & Unwin).Google Scholar
- Isard, P. (1978) ‘Exchange Rate Determination: a Survey of Popular Views and Recent Models’, Princeton Studies in International Finance, no. 42.Google Scholar
- MacDonald, R. and Taylor, M. P. (1989) ‘Economic Analysis of Foreign Exchange Markets: an Expository Survey’, in R. MacDonald and M.P. Taylor (eds), Innovations in Open Economy Macroeconomics (Oxford: Basil Blackwell).Google Scholar