ABSTRACT
What determines the exchange rate? In later chapters, we will be discussing the traditional macroeconomic fundamentals, but in this chapter we discuss the asset approach to the exchange rate. This is in line with the forward-looking intertemporal approach, which the new open economy macroeconomics has emphasised. It treats currency as an asset and the exchange rate as the price of the asset. Since an asset transfers purchasing power from present to future, its price today depends on the expected future value. As an asset, the exchange rate becomes a jump variable that can change rapidly with a change in expectations. We will see that it can also overcompensate for other sticky macroeconomic prices such as wages and goods prices.
