Process analysis essays

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Process analysis essay

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Unless speculative influences operate on a large scale, the extent to which forward rates tend to move towards Purchasing Power Parities is comparatively small. It is mainly in a 'gamblers' market' that the Purchasing Power Parity Theory of Forward Exchange operates to a sufficiently large degree to assume a really considerable importance from a practical point of view. When dealing with such an essentially concrete subject as Forward Exchange we should at all costs avoid that cult of mysticism which is so largely to blame for the frequent clash of economics and reality. Professor Cassel's Purchasing Power Parity theory of spot exchanges conveyed the impression that he believed in the existence of some mysterious urge forcing spot exchanges to adjust themselves to their Purchasing Power Parities. This mystical conception had secured such a hold that for a long time after the elaboration of the theory nobody had attempted to penetrate behind the veil of mysticism and come down to concrete facts to show exactly how the theory actually worked.

Fortunately, in the case of the Purchasing Power Parity theory of Forward Exchange, we are able to ascertain all the factors, whether material or psychological, through which the theory operates in practice. To the extent to which Purchasing Power Parities tend to affect forward rates they exert their influence through a set of very definite and easily defined factors, as we have seen above.In its original form Cassel's theory was essentially static, not only because it abstained from process-analysis but also because it conveyed the static conception that any deviations from equilibrium were bound to be temporary, without making it clear that, as likely as not, they are liable to become corrected by an adjustment of Purchasing Power Practice to exchange rate instead of by a readjustment of interest rates to Purchasing Power Parities. A dynamic theory would have allowed for the effect of exchange rates on price levels, just as a dynamic theory of Forward Exchange allows for the effect of forward rates on interest rates.

We must guard ourselves against falling into the same error of omission as did Cassel. When applying his theory to Forward Exchange we must combine Syrett's static theory with a dynamic theory. It is doubtless essential to realise the existence of a tendency for forward rates to adjust themselves to the Purchasing Power Parities of spot exchanges, even if that influence is not nearly as strong and distinct as the tendency for them to adjust themselves to their Interest Parities. It is equally essential, however, to realise that forward rates themselves tend to influence the price levels on which Purchasing Power Parities are based.

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