Monetary approach postulates that the rates of exchange are determined through the balancing of the total demand and supply of the national currency in each country.
According to this approach, the demand curve for money depends upon the level of real income, the general price level and the rate of interest.
The demand for the money is the direct function of the real income and the level of prices.
On the other hand, it is an inverse function of the rate of interest. As regards, the supply of money, it is determined autonomously by the monetary authorities of different countries.
It is assumed that initially the foreign exchange market is in equilibrium or at interest parity. It is further supposed that the monetary authority in the home country increases the supply of money. This will lead to proportionate increase in price level in the home country in the long run.
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