The monetary theory in regard to exchange rates suggests that the nominal exchange rate is determined by contemporaneous excess supplies of money between United Kingdom and the other trading nation. Nations that adopts and adhere to a relatively restrictive monetary policy usually experience an appreciation of their currencies against that of their trading partners, while the nations that adopt and adhere to a relatively expansionary monetary policy experience a depreciation of their currencies against that of their trading partners. Therefore, theory application in practical aspect of econometrics in relation to exchange rate determination helps to project the proportional relationship between the relative money supply and the exchange rates between the bilateral trading nations for a specific period of time.
The aspect of the theory that enables it to project the proportional relationship between the relative money supply and the exchange rates between trading partners ofBritain, is important and has tangible and intangible implications at levels of policy, empirical and theoretical. For instance, at theoretical level the monetary approach is the basis foundation forUnited Kingdomopen economy. The theory of open economy was adopted from work of Lucas (1982) of open economy quantity theory. While at policy level, the theory has impact on the structural adjustment programs. These structural adjustment programmes are sponsored by IMF, World Bank and exchange rate misalignment in monetary unions thatUKis a partner like EMU (European Monetary Union). Due to this domestic and global implication of the monetary model, it has not only been widely accepted, but also widely tested model for exchange rates in econometrics.
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