Abstract
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.
