EXCHANGE RATE DETERMINATION: A DIFFERENT PERSPECTIVE

Purchasing Power Parity and Interest Rate parity are well established theories of exchange rate determination. Purchasing Power Parity is basically the law of one price, a basket of goods and services are priced in one country and the same basket of goods and services are priced in another country and the exchange rate is determined based on the prices of the commodity basket in each country. Interest rate parity is another theory which states that the interest rate parity determines exchange rate. This paper finds that although purchasing power parity and interest rate parity are well established theories of exchange rate determination, but there are other variables which are unique for each country for determining exchange rate for those individual countries. Therefore we cannot say that exchange rate of every country is determined by purchasing power parity or interest rate parity alone. This paper finds that for each individual country the variables that determine exchange rate are unique and different.