The Interest Rate Approach
This involves a number of different principles. The first principle involves the basic interest rate parity theory. Interest rate parity theory states that the difference between a spot and forward exchange rate expressed as a percentage should equal the interest rate differential between the two currencies. The differential through the interest rate parity theory, which in turn equates to the difference in expected inflation rates though the Fisher effect. Yet, PPP tells us that absolute or relative price growth levels can be used to forecast future exchange rates.