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What does The monetary approach assume In the long run?
That the level of the nominal exchange rate depends on the size of the money supply as this determines price levels.
What are some Problems with PPPs?
- There is weak empirical support for the monetary approach as an explanation for exchange rates in the long run.
- Relative PPP does better than absolute PPP but still something is missing.
What are Reasons for the failure of the purchasing Power theory and thus monetary approach?
- Trade barriers and non-traded products, if goods and services are not traded their price will not be equalized.
- Imperfect competition, Due to economies of scale firms set different prices in different markets so there is different prices for the same Product and therefore we can’t apply the same price level to a basket of goods.
- Different basket of goods, we Produce and consume different Products in different Countries.
What does The monetary factors from the monetary approach need to be complemented with?
real factors. Like q = real exchange rate. The Price of a country’s goods and services in terms of other countries goods and services.
Why do some state that The level of real exchange rate is unimportant?
Because you can have different baskets of goods or different price levels in different countries.
What is it called when q↑ and what does it mean?
Real depreciation, then we need to pay more of our goods for the goods in the rest of the world (Row)
What is it called when q↓ and what does it mean?
Real appreciation, then we need to pay less Of our goods for the Row’s goods.
What does Real exchange rate depends on in the Short run?
nominal exchange rate and price levels in different countries.
What does the real exchange rate depends on in the Long run?
Same relationship between the variables, but it is the nominal exchange rate that adjusts.
What does The real exchange rate approach states?
That the long-term nominal exchange rate depends on real factors (q) and monetary factors.
What is RS and what is it determined by?
- Relative supply in the Long term,
- determined by labour, capital and technology.
- Not dependent on real exchange rate.
What is RD?
Relative demand in the long term
Demand for home country goods relative to foreign goods.
What happens with RD With real depreciation (q↑)?
Our goods become cheaper relative to the Row and relative demand for them increases.
What does The monetary approach states?
That the nominal exchange rate in the long run is given by monetary factors.
What does a Permanent increase in the money supply leads to?
a nominal depreciation.
