The question asks for the theory used for long-term predictions of exchange rates within a flexible exchange rate system.
Purchasing Power Parity Theory for Exchange Rates
Purchasing Power Parity (PPP) Theory is the primary theory used for making long-term predictions about exchange rates in a flexible exchange rate system.
- PPP theory suggests that the exchange rate between two currencies should equalize the price of an identical basket of goods and services in any two countries.
- In the long run, exchange rates are expected to adjust towards the rate that would make the prices of goods comparable across countries.
- This theory focuses on the general price levels and the long-term equilibrium of exchange rates, making it suitable for long-term forecasting.
Other Theories and Their Relevance
The other theories mentioned are not primarily used for long-term exchange rate predictions in a flexible system:
- Dow Theory: Primarily used for analyzing stock market trends, not currency exchange rates.
- Behavioural Economics Theory: Focuses on psychological influences on economic decisions, which can affect short-term market fluctuations but isn't a primary tool for long-term exchange rate forecasting.
- Game Theory: Analyzes strategic interactions between rational decision-makers, applicable in specific economic scenarios but not the main theory for long-term exchange rate predictions.
Conclusion
Therefore, Purchasing Power Parity Theory is the correct choice for understanding long-term exchange rate movements under flexible exchange rates.
Important Questions from External Sector and Currency Exchange rate
- At the Eighth Session of the International Solar Alliance (ISA) Assembly held at Bharat Mandapam in October 2025, which of the following initiatives was launched to address solar waste and promote circularity in the solar sector?
- The reduction in the external value of the domestic currency is called:
- Under a freely exchange rate system, a deficit in a Nation’s Balance of Payments Account is automatically corrected by
- MNCs can help the developing countries to:
(a) Obtain foreign technology and innovative methods of increasing productivity
(b) Employ rural unemployed labour
(c) Finance a savings gap or balance of payments deficit
(d) Generate appropriate technology by adapting existing processes
Choose the correct answer from the code given below : Exchange rates state the value of one currency in terms of other currencies. Which one of the following statements with respect to the exchange rate of a currency is correct?
