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Monetary Model
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A model of exchange rate determination that is an extension of the quantity theory of money to an open economy. There are two variations of the monetary model: the flexible price monetary model and the sticky price monetary model. The flexible price monetary model assumes that purchasing power parity holds and that changes in relative price levels automatically translate into changes in exchange rates. The sticky price monetary model assumes that prices are sticky in the short run. Thus a change in the nominal money supply causes a change in the real money supply resulting in interest rate changes and capital flows. These capital flows cause the exchange rate to overshoot the changes that would have occurred had prices adjusted instantaneously.
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Glossary *
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