Essay: Exchange Rate in the UK-Theoretical Model
In order to determine the exchange rates in UK, the use of theoretical and empirical methodology is inventible as suggested by economists Paul and Glassman, (2007). This is because the error in arriving at conclusive results is reduced through combination of these two mechanisms.
In economics working out of exchange rates and considerations the basic variables are the purchasing power parity and quantity theory of money. The two variables are fundamental cornerstones in the monetary approach. Therefore empirically economists can approximate theoretically the exchange rates using factors like spot exchange rate of pound per unit of foreign currencies (Richardson 1979).
However, to approximate the theoretically identified factors to this model, there should be a combination of two components. These components are: purchasing power parity relationship to link the exchange rate with the price levels; and the money demand functions of the home countries which in this case the UK and foreign country which can be taken to be the bilateral trade partner.