The Monetary Approach to Exchange Rate Determination; An Inconsistent Paradigm!!!

The exchange rate plays a vital role in a country's level of foreign trade, which is critical to most free market economies in the world. Mostly, an exchange rate is used as one of the most important determinants of a country's relative level of economic health. Due to its significance in international trade, many researchers have tried to develop models which build relationships between forces that determine the magnitude and movement of the exchange rates. This paper accumulates theoretical and empirical findings of monetary approach to exchange rate determination. Conventionally, the monetary approach to exchange rate determination claims that devaluation of the currency will improve the trade balance. However, there have immerged facts which deify this claim. Findings as summarized in this paper, suggest that, the monetary approach is an inconsistent approach. Thus, while it holds true to some countries, data from some other countries have been found to extremely contradict with this approach.Generally, despite the availability of models which are used to predict or determine exchange rate pattern, such models have been brutally attacked by empirical facts.