Balance of Payments Approach
It looks very much at the idea that the balance of payment flows has on the exchange rates between currencies.
Basically it is saying that if there is a deficit in the level of a trade, then that will lead to the home currency being worth a bit less, however the natural outcome of it dropping will be that imports will fall and exports will start to rise because it is cheaper for those abroad to buy from that country but more expensive for those in the country to buy from outside due to its weaker currency.
And as we expect this will stabilise as a new exchange rate is reached.
Using the Balance of Payments model it can be seen that there are various factors to consider.
These include important the link between imports and exports and exchange rate changes. Also if note is the link between import levels and inflation in the home market, and more generally how all the individual changes and factors interlink and interplay with each other.
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