Optimal and sustainable exchange rate regimes : the case of PTA countries

Abstract

An exchange rate, being a "price," has both nominal and real values. However, an exchange rate is also an embodiment of developments in the economy in the real and monetary sectors and thus, more than just a "price." In accordance with the theory of "purchasing power parity," the exchange rate adjusts to differential movements in absolute levels, particularly movements resulting from differential rates of monetary expansion. When countries have widely differing inflation rates and rates of monetary expansion, exchange rates move roughly in sympathy with relative purchasing power parities. However, the exchange rate also adjusts to accommodate changes in relative price of different national outputs, dictated by changes in underlying real economic conditions. Accordingly, the exchange rate is also identified with the relative price of imported (or tradable) goods in terms of domestic (or non tradable) goods.