International Journal of

Business & Management Studies

ISSN 2694-1430 (Print), ISSN 2694-1449 (Online)
Monetary Policy, Money Market, and Exchange Rate Determination


The money market approach to exchange rate determination is part of the Asset Market Models and is largely attributed to economists after 1973 when the exchange rate became flexible (market determined). This article, first, introduces, the setting of the model embedded in the money market equilibrium equation with the use of the spot exchange rate as an independent variable in the money demand equations for the two countries. Then, the spot rate is determined from these money market functions. Consequently, the exchange rate is determined through the classical equation of exchange. These models deviate a little from the models and approaches used for the monetary approach to the balance of payment, the overshooting model, and from the associated market equilibria. The effects of monetary policy (federal funds rate, monetary base, and money supply), of wealth (income), and of the price level (real money supply) under the money market approach are examined, here, theoretically and empirically. The current econometric results show that the exchange rate is determined by the monetary policy in the two countries (domestic and foreign money supply, income, interest rate, and velocity of money). The new monetary policy has questionable and ethical implications for our economy and society.