Monetary Theory (Exchange Rate Determination Theory)

Saturday, September 12, 2009

The monetary theory of the exxchange rate is the proposition that the exchange rate adjusts to make the stock of a currency demanded equal to the stock supplied. The stock of currency is identical to the quantity of money. According to the Monetary Theory, the exchange rate adjusts to ensure that the quantity of money in each currency supplied equals the quantity demanded.

Some international economist regard the monetary theory of exchange rate as too narrow and suggest that a broader aggregate should be considered. This consideration gives rise to the portfolio balance theory.