Document Type

Report

Publication Date

6-1987

Number

171

Abstract

The popularity of the Monetary Approach to the Balance of Payments and the Exchange Rate brought renewed interest in Purchasing Power Parity (PPP). The essence of the Monetary Approach as advocated by Johnson (1976) and Frenkel (1978) was to combine a simple theory of the demand for money with the Purchasing Power Parity relationship in order to 'explain' movements in a nation's Official Settlements Balance or exchange rate. Lately, the Monetary Approach has come under attack because of large and persistent measured devia tions from PPP, Daniel (1986) and Dornbusch (1980) view these deviations as symptomatic of 'sticky' commodity prices; if commodity prices are sticky, changes in the nominal exchange rate will induce changes in the real exchange rate arid in deviations from PPP. Others attempt to explain the observed deviations within the context of a flexible-price framework; productivity changes, as in Stockman (1987), or delivery lags, as in Magee (1978), can give rise to optimal movements in a nation's real exchange rate. In spite of these different views, there is a wide support for the following synthesis of Mussa's (1979) 'stylized facts':

Published As

This paper is published in Journal of International Money and Finance, Vol. 8, No. 1 (March 1989), pp. 59-73

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