Question

Explain in. The. Metheds of exchange rate determination

Answer 1

There are two methods of foreign exchange rate determination. One method falls under the classical gold standard mechanism and another method falls under the classical pa­per currency system. Today, gold standard mechanism does not operate since no stand­ard monetary unit is now exchanged for gold.

All countries now have paper currencies not convertible to gold. Under inconvertible pa­per currency system, there are two methods of exchange rate determination. The first is known as the purchasing power parity theory and the second is known as the demand-sup­ply theory or balance of payments theory. Since today there is no believer of purchasing power parity theory, we consider only demand-supply approach to foreign exchange rate determination.

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