What is Mint Parity Theory of Exchange Rate System?
There are various theories for the determination of the exchange rate in Nepal. The major theories are
- Mint Parity Theory: Gold Standard Theory
- Purchasing Power Parity Theory
- BoP Theory of Exchange Rate
Mint Parity Theory: Gold Standard Theory
This is an ancient theory that is no longer commonly used. This theory of exchange rate determination is used to find the exchange rate between the currency if they are made up of gold or such precious metals, or can be freely converted to gold of a fixed amount with the given purity.
Under this theory, we calculate the exchange rate between the currencies by making a weight-to-weight comparison of the currencies.
For example, if 1 NPR contains 2 grams of gold and 1 INR contains 3 Grams of gold of the same purity, then the exchange rate between NPR and INR is 1 NPR = 0.6 INR.
The exchange rate between the currency is fixed in terms of the gold content or minted rate. The central bank can buy and sell any quality of forex or gold at the fixed minted rate. However, the market exchange rate may be slightly different from the minted rate given the BoP position of the economy. But the market rate remains within a narrow and stable limit.
Here,
- M*M* is the minted exchange rate which is fixed due to the fixed amount of gold.
- L*L* is the lower limit of the exchange rate and it is knows as gold import point which means if the exchange rate of the forex fall from L*, it is profitable to import gold.
- U*U* is the upper limit of the exchange rate which is the gold export point because export of gold is profitable to the market if the exchange rate is higher than U*.
- The market exchange rate is determined by the demand and supply of the forex in the market.
- Both demand and supply of the forex are equal at E* and so R* is the market equilibrium rate which may be lower, higher or equal to the M*.