There is an extensive literature on the factors determining the level of a floating exchange rate, and in particular its behaviour over time. In this chapter we shall discuss a selection of the models that have been proposed.1 We may identify the two extremes as the ‘Keynesian’ models where prices and wages are assumed fixed, and ‘monetary’ models in which they are assumed to be perfectly flexible, and some form of purchasing power parity is assumed to hold. Within both these broad groups we find considerable differences, in particular in the treatment of international capital flows. We shall consider simple versions of these in turn.
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