In contrast with the BOP theory of foreign exchange, in which the rate of exchange is determined by the flow of funds in the foreign exchange market, the monetary approach postulates that the rates of exchange are determined through the balancing of the total demand and supply of the national currency in each country. The following points highlight the top four theories of exchange rates. The theories are: 1. Purchasing Power Parity Theory (PPP) 2. Interest Rate Parity Theory (IRP) 3. International Fisher Effect (IFE) Theory 4. Unbiased Forward Rate Theory (UFR). Since the task of exchange rate theory is to explain be- havior observed in the real world, the essay begins (in sec. 1.2) with a summary of empirical regularities that have been characteristic of the behav- ior of exchange rates and other related variables during periods of floating exchange rates.

Balance of Payment theory, also known as the Demand and Supply theory, holds that the foreign exchange rate, under free market conditions is determined by the conditions of demand and supply in the foreign exchange market. According to this theory, the price of a commodity that is , exchange rate is determined just like the price of any commodity is determined by the free play of the force of demand and supply. According to the Balance of Payments theory, changes in a country’s national income affect the country’s current account. Consequently, the exchange rate is adjusting in a new level in order to achieve a new balance of payments equilibrium. Before moving forward, let us define the balance of payments and the balance of trade. PPP as a Theory of Exchange Rate Determination. The PPP relationship becomes a theory of exchange rate determination by introducing assumptions about the behavior of importers and exporters in response to changes in the relative costs of national market baskets. In the PPP theory, exchange rate changes are induced by changes in relative price levels between two countries. This is true because the quantities of the goods are always presumed to remain fixed in the market baskets. Therefore, the only way that the cost of the basket can change is if the goods’ prices change. 2. EXCHANGE RATE THEORIES IN SUCH A SITUATION, THE COUNTRIES EXPORTS WILL BE CHEAPER TO FOREIGNERS AND IMPORTS WILL BE COSTLIER FOR RESIDENTS. THE RESULT IS THAT THE NATIONS EXPORTS TEND TO RISE AND THE IMPORTS TEND TO FALL TILL THE BALANCE IN RESTORED. THE SPEED OF THE ADJUSTMENT WILL DEPEND UPON THE Five Traditional Exchange Rate Models. The traditional exchange rate models seek for the identification of an equilibrium between two economies in order to calculate the fair value of the exchange rate. An equilibrium based on the relative valuation of an identical commodity, on relative inflation, on the relative level of real interest rates, etc.

the behaviour of exchange rate. As documented in Atoi and Nkwede (2017), the theory explains that exchange rate between two currencies will adjust to reflect 

In the PPP theory, exchange rate changes are induced by changes in relative price levels between two countries. This is true because the quantities of the goods are always presumed to remain fixed in the market baskets. Therefore, the only way that the cost of the basket can change is if the goods’ prices change. 2. EXCHANGE RATE THEORIES IN SUCH A SITUATION, THE COUNTRIES EXPORTS WILL BE CHEAPER TO FOREIGNERS AND IMPORTS WILL BE COSTLIER FOR RESIDENTS. THE RESULT IS THAT THE NATIONS EXPORTS TEND TO RISE AND THE IMPORTS TEND TO FALL TILL THE BALANCE IN RESTORED. THE SPEED OF THE ADJUSTMENT WILL DEPEND UPON THE Five Traditional Exchange Rate Models. The traditional exchange rate models seek for the identification of an equilibrium between two economies in order to calculate the fair value of the exchange rate. An equilibrium based on the relative valuation of an identical commodity, on relative inflation, on the relative level of real interest rates, etc. The general theory of the balance of payments constructed in the previous chapter may, with little difficulty, be modified to become a general theory of exchange-rate determination. With flexible exchange rates, a position of equilibrium as represented by a point of intersection between IS and LM, which lies off the BP schedule will result in a A four-period classification is used to categorise recent exchange-rate theories or models. In the very short period, only capital flows are relevant. In the short period, both capital flows and payments on the current account play a role. In the long period, the capital account and the current account are individually in equilibrium. In the very long period, purchasing power parity holds

The theories of the exchange rate began to flourish in the beginning of 1960s. Short-term behaviour of exchange rates can be explained by the uncovered 

Exchange rates. The equilibrium exchange rate is the rate which equates demand and supply for a particular currency against another currency. Example. If we  foreign currency while depreciation in exchange rate occurs if more unit of Real and Monetary Determinants of Real Exchange Rate Behaviour: Theory and   In contrast with the BOP theory of foreign exchange, in which the rate of exchange is determined by the flow of funds in the foreign exchange market, the monetary approach postulates that the rates of exchange are determined through the balancing of the total demand and supply of the national currency in each country. The following points highlight the top four theories of exchange rates. The theories are: 1. Purchasing Power Parity Theory (PPP) 2. Interest Rate Parity Theory (IRP) 3. International Fisher Effect (IFE) Theory 4. Unbiased Forward Rate Theory (UFR). Since the task of exchange rate theory is to explain be- havior observed in the real world, the essay begins (in sec. 1.2) with a summary of empirical regularities that have been characteristic of the behav- ior of exchange rates and other related variables during periods of floating exchange rates. Real Exchange Rate Behavior and Market Characteristics A large body of work has sought to characterize the adjustment of the real exchange rate toward its long-run value. Often, the long-run real exchange rate is thought to be what sets the price of identical baskets of goods to be equal, when expressed in common currency terms; this condition often is termed purchasing power parity.

10 Apr 2014 In the long run this theory may explain the behaviour of exchange rates. The base of the purchasing-power parity theory is the law of one price.

The standard flow market model which dominates textbook ' 'ons of the foreign exchange market was found to be essentially uselss -as a tool for explaining and. understanding the behavior of exchange rates and other rela%d -miaThe behavior of exchange rates, however, was found `to be txo.stent with a general asfet market view of the exchange rate. Exchange Rate Theory and “the Fundamentals” If this behavior of short-run expectations increases the volatility of exchange rate movements, there may be a basis for an official measure to

A four-period classification is used to categorise recent exchange-rate theories or models. In the very short period, only capital flows are relevant. In the short period, both capital flows and payments on the current account play a role. In the long period, the capital account and the current account are individually in equilibrium. In the very long period, purchasing power parity holds

Balance of Payment theory, also known as the Demand and Supply theory, holds that the foreign exchange rate, under free market conditions is determined by the conditions of demand and supply in the foreign exchange market. According to this theory, the price of a commodity that is , exchange rate is determined just like the price of any commodity is determined by the free play of the force of demand and supply. According to the Balance of Payments theory, changes in a country’s national income affect the country’s current account. Consequently, the exchange rate is adjusting in a new level in order to achieve a new balance of payments equilibrium. Before moving forward, let us define the balance of payments and the balance of trade. PPP as a Theory of Exchange Rate Determination. The PPP relationship becomes a theory of exchange rate determination by introducing assumptions about the behavior of importers and exporters in response to changes in the relative costs of national market baskets. In the PPP theory, exchange rate changes are induced by changes in relative price levels between two countries. This is true because the quantities of the goods are always presumed to remain fixed in the market baskets. Therefore, the only way that the cost of the basket can change is if the goods’ prices change.

I. Movements of real yen-dollar and DM-dollar exchange rates . behaviour that would be required to render such expectations rational, the time Fukao, M. (1 9831, "The theory of exchange rate determination in a multi-currency world",  in the case of Brazil, rather than a “fear-of-floating” behaviour, Brazil's Central The PPP theory, which defines the real exchange rate as the relative price of a  10 Apr 2014 In the long run this theory may explain the behaviour of exchange rates. The base of the purchasing-power parity theory is the law of one price. Exchange rates. The equilibrium exchange rate is the rate which equates demand and supply for a particular currency against another currency. Example. If we  foreign currency while depreciation in exchange rate occurs if more unit of Real and Monetary Determinants of Real Exchange Rate Behaviour: Theory and   In contrast with the BOP theory of foreign exchange, in which the rate of exchange is determined by the flow of funds in the foreign exchange market, the monetary approach postulates that the rates of exchange are determined through the balancing of the total demand and supply of the national currency in each country. The following points highlight the top four theories of exchange rates. The theories are: 1. Purchasing Power Parity Theory (PPP) 2. Interest Rate Parity Theory (IRP) 3. International Fisher Effect (IFE) Theory 4. Unbiased Forward Rate Theory (UFR).