ABSTRACT
Purchasing power parity (PPP) is an important component of the monetary approach (MA) in which relative money supplies are the fundamentals determining the nominal exchange rate. A key component of the MA is the money market equilibrium, which determines the nominal interest rates, thus endogenising another variable we have so far taken as given. The MA to the exchange rate can be divided into the flexible price monetary approach (FPMA) and the sticky price monetary approach (SPMA). FPMA is the standard MA. The asset price approach to the determination of exchange rates, explored in Chapter 3, plays a major part in the SPMA. The FPMA is presented in addition to the SPMA, and the very different behaviour of the interest rate under the SPMA compared to the FPMA is drawn out.
