Question

Briefly discuss what causes short run and long run changes in exchange rates. Be sure to include key terms such as asset market approach to exchange rates, purchasing power parity, and the monetary approach to exchange rates.

Answer 1

Foreign exchange market is a market in which purchase and sale of currencies of different countries are made.There are different reasons for short run and long run changes in exchange rates.
1.Asset Market Approach - It is one of the method of determination of exchange rate in the long run.This method includes approach foreigners are ready to invest in other countries according to interest rates and also consider profitability and growth prospects of home country.If they are motivated by long run prospects they makes investments.
2.Purchasing power parity -The theory of purchasing power considers the ratio of price levels between two countries is almost same to their exchange rates.prices are determined by combination of goods and services available in market and do not changes by transportation cost.when there is inflation,exchange rate declined as inflation and exchange rates are inversely related with each other.
3.Monetary Approach
Depends on types of exchange rates i.e.fixed and flexible exchange rate ,in flexible exchange rate change in monetary policy also give proportional changes in exchange rate .As money supply increases change in exchange rates are also more and when money supply restricted change is comparitely less.