Monetary Policies and Exchange Rates

In this paper we set out to do three things. First we present a general, and somewhat simple, theory of the relationship between monetary policies and exchange rates. Second we present some evidence relating to the theory. Third we use the theory to discuss current relationships between European currencies and in particular examine the prospects for the European Monetary System and for the pound sterling. The following account does not attempt to provide a realistic theory of short-term movements in the exchange rate but sets out a general approach which describes the longer-term tendencies of exchange rates. It has been described by a distinguished commentator as « naive instant monetarism ». « Naive », presumably, in the sense that it pays no attention to institutional problems and « instant » in the sense that the adjustments appear to occur instantaneously. The sense in which it is monetarist should become clear although we draw attention to one theoretical objection to the monetarist approach. We make no claim for originality for the theoretical framework.