The Portfolio-Balance Model of Exchange Rates

Abstract

Since the collapse of the Bretton Woods regime, models of asset-stock equilibrium have dominated professional thinking about exchange-rate determination. A number of empirical investigations have established that changes in relative stocks of money explain a considerable portions of the behavior of echange rates. It has also been established, however, that persistant deviations from purchasing-power parity weaken the links between exchange rates and relative stocks of money in the shorts run, and that relative rates of money growth by themselves do a poor job of explaining the behavior of exchange rates since late 1975, when real economic growth in the United States recovered to a rate of exceeded and continued to outpace growth rates in other industrialized countries.

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