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CH03- Exchange Rates I - Monetary Approach in the LR-part1 - 2 slides- S13

Ppp says e equals the ratio of the price levels 23

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PPP says E equals the ratio of the price levels. 23 Now, substituting for prices using the money market equilibrium conditions we get: The Monetary Approach: A Simple Model of the Exchange Rate 24 This is the fundamental equation of the monetary model of the exchange rate .
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5/23/2013 13 The Monetary Approach: Money, Growth, and Depreciation Monetary model can be also expressed in terms of rates of change . Let growth rate of money supply M be : 25 Monetary model can be also expressed in terms of rates of change . The Monetary Approach: Money, Growth, and Depreciation Let growth rate of real income Y be g : 26
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5/23/2013 14 From the levels equation The Monetary Approach: Money, Growth, and Depreciation Can derive the growth rate equation – note L is assumed to be constant for the moment: 27 Same applies for Europe: The Monetary Approach: Money, Growth, and Depreciation Important result: inflation equals the excess of money growth over real output growth. 28
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5/23/2013 15 Where does all this get us? The Monetary Approach: Money, Growth, and Depreciation To some clear and testable predictions. Combining these growth equations with relative PPP we obtain: 29 The Monetary Approach: Money, Growth, and Depreciation 30
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5/23/2013 16 Exchange Rate Forecasts Using the Simple Model Read (and understand!) section on this subject pages 82 – 85 including figure 3-6. 31
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