This is to say that the equation that is given for the PPP will hold well with some constant may be incorporated to make-up for the deviations that might occur. Overall such changes will be required every time.
The Monetary Approach
The floating exchange rate models were given in 1970s. Various tests have been performed to study and demonstrate how the model has been accepted in providing evidence for the exchange rate estimation. The validity of the model has been discussed above and shows that there are mixed reactions in relation to the results of the model. In one of the important studies it was shown that the model actually resulted in increase in inflation in Zaire, however, it seems that hyperinflations offer natural testing grounds for the monetary approach model.
The other studies that have been included in the study are as follows
GBP USD exchange rate from 1972 to 1977 by Putnam and Woodbury
DEM USD exchange rate from 1973 to 1975 by Hodrick
These two studies have shown positive results for the monetary approach. Thus overall the empirical testing of the model is quite encouraging. Although there are certain factors and results that show that model isn’t showing relevant results but certainly is a strong base to conduct further studies for better estimation of the exchange rate. Although the simplicity of the model may result in ambiguous results but controlling the factors that have been stated in the assumptions would certainly increase the effectiveness of the model. For example Meese and Rogoff (1983) —conducted the seminal work in the use of monetary models to forecast the exchange rate. In this the log of the exchange rates was regressed on different combinations of the relative macroeconomic variables that were included in the exchange rate model.