Modern Monetary Theory or Modern Money Theory (MMT)

The Modern Monetary Theory is an alternative to the traditional macroeconomic theory. Generally, MMT suggests that there is no limit to the quantity of money that can be created by a central bank. The only limit comes from the impact of inflation. In short, MMT suggests that countries and governments controlling reserve currencies can borrow and spend as much as they need to achieve employment, and later, create more currency to repay their debt.

MMT Economists are focused on fiscal policies

According to MMT, governments can create new money through their fiscal policy. The government’s fiscal policy is focused on budgeting and includes:

• Taxation

• Government spending, and

• Transfer payments

Five Traditional Exchange Rate Theories

The traditional exchange rate models seek the identification of an equilibrium between two economies to calculate the fair value of the exchange rate. An equilibrium is based on the relative valuation of an identical commodity, relative inflation, relative level of real interest rates, etc.

These are the key exchange rate models and the relative pricing method they use:

1. Purchasing Power Parity (PPP) → Relative pricing of goods

The Purchasing Power Parity (PPP) model or else the “law of one price” estimates the adjustment needed on the exchange rate between countries for the exchange to be equivalent to each currency's purchasing power.