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Discuss the flexible price monetary model of exchange rate determination and its ability to explain foreign exchange movements. How realistic is the assumption that prices are fully flexible Does this model perform well when tested empirically - Essay Example

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These are trade in goods and services and the trade in financial assets such as futures, hard currency, and interest rate swaps. In the era before the world embraced financial liberalization, governments of countries…
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Discuss the flexible price monetary model of exchange rate determination and its ability to explain foreign exchange movements. How realistic is the assumption that prices are fully flexible Does this model perform well when tested empirically
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Extract of sample "Discuss the flexible price monetary model of exchange rate determination and its ability to explain foreign exchange movements. How realistic is the assumption that prices are fully flexible Does this model perform well when tested empirically"

Download file to see previous pages This model assumed that countries with positive trade balances or surpluses would have a currency that appreciates whereas countries with negative trade balances will have a currency that is depreciating. However, this assumption is incorrect as there are countries, which enjoy surpluses in trade but still have their currencies depreciating. The trade in financial instruments has also surpassed that of the traditional goods and services. This is attributed to financial liberalization. This paper will thus attempt to discuss monetary models of exchange rate determination, specifically the flexible price monetary model and its ability to explain foreign exchange movements. It will also discuss the assumption that prices of commodities are fully flexible, and finally examine the effectiveness of the flexible price monetary model when it is empirically tested.
The reliance on the concept that trade flows determine exchange rates did not hold. There are models today, which governments use to determine the exchange rates of currency in their respective currencies. The International Monetary Fund (IMF), the world body that monitors and advises on the economies of member states, allows member countries to have and operate any of the three exchange-rate determination models (Marston, 2011:45). These three monetary models are; the fixed exchange rate, the intermediate exchange rate, and the flexible exchange rate. It is important, before we discuss the flexible exchange rate monetary model, to examine the other two models and their roles in exchange rate determination.
In the fixed exchange rate model, the authority charged with the responsibility of managing the country’s currency exchange rate, usually the central bank, fixes the domestic currency to a foreign currency. For instance, if Switzerland operates a fixed exchange rate model, it would fix its Swiss Francs to say the dollar. Since the rate has been predetermined and fixed, any changes in ...Download file to see next pagesRead More
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