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102 CHAPTER 3. THE MONETARY MODELMonetary Model Summary1. The monetary model builds on purchasing-power parity, uncoveredinterest parity, and stable transactions-based money demandfunctions.2. Domestic and foreign money and real income levels are the fundamentaldeterminants of the nominal exchange rate.3. The exchange rate is viewed as the relative price of two monies,which are assets. Since asset prices are in general more volatilethan their fundamentals, it comes as no surprise that exchangerates exhibit excess volatility. The present value form of thesolution underscores the concept that the exchange rate is anasset price.4. The monetary model is a useful Þrst approximation in Þxingour intuition about exchange rate dynamics even though it failsto explain the data on many dimensions. Because purchasingpower parity is assumed to hold as an exact relationship, themodel cannot explain the dynamics of the real exchange rate.Indeed, the main reason to study nominal exchange rate behavioris if we think that nominal exchange rate movements arecorrelated with real exchange rate changes so that they havereal consequences.