Question

Question One [30 marks] 1.1. Critically discuss the PPP, monetary approach and portfolio balance theory for the exchange rate and balance of payment?

Answer 1

PPP approach is a traditional approach which focuses on maintaining the equilibrium between the exchange rate in different countries and it will try to maintain a purchasing power parity by adjustment of the exchange rates and it will advocate that prices of goods in different countries will remain the same when we will be accounting in for the exchange rate and it will be leading to effect on the balance of payment and exchange rate through adjustment of these prices to equilibrium.

In the monetary approach of determination of the exchange rate and the balance of payment,the exchange rate between two currencies are determined by the relative pricing of money demand and money supply. The demand of money and supply between the two country will be determined in the exchange rate and this will be used through the monetary approach of determination in respect to balance of payment and exchange rate.

portfolio balance approach for determination of exchange rate and balance of payment is inclined at relative Bond supplies and Bond demand along with the money market condition in order to determine the exchange rate between two countries.

Hence, these are the three approaches in respect for determination of the exchange rate and the balance of payment.