Monetary approach to determine exchange rate
Derive and explain monetary approach in order to determine the exchange rate.
Expert
Monetary approach is related with Chicago School of Economics. This method is based upon the two tenets: the quantity theory of money and purchasing power parity. Joining these two theories permits stating, say, the $/£ spot exchange rate as:
S($/£) = (M$/M£)(V$/V£)(y£/y$),
Where, V the velocity of money, M denotes money supply, and y the national aggregate output. Theory holds that what matters in the exchange rate determination are:
a) Relative velocities of monies,
b) Relative money supply, and
c) Relative national outputs.
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