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Derive and illustrate the monetary approach to exchange rate determination.
Answer: The monetary approach is related with the Chicago School of Economics. It is relies on two tenets: quantity theory of money and purchasing power parity. Combing these types of two theories permits for stating, say, the $/£ spot exchange rate is as follow:
S($/£) = (M$/M£)(V$/V£)(y£/y$),
In which M stands for the money supply, V denotes velocity of money, and y stands for national aggregate output. The theory carries out that what matters in exchange rate determination are:
a. The relative money supply,
b. The relative velocities of monies, and
c. The relative national outputs.
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