In other  words, the degree to which the
exchange rate responds to a change in the trade  balance depends entirely on the elasticity of
demand to a change in price. For instance, if the imports of country A are strong, then the trade
balance is weak. Consequently, the exchange rate rises, leading to the growth of country A's
exports, and  triggers in turn a rise in its domestic income, along with a decrease in its foreign
income. Whereas  a rise in the domestic income  (in country A) will trigger an increase in the
domestic consumption of  both  domestic and foreign goods and, therefore,  more demand for
foreign currencies, a decrease in the foreign income (in country B) will trigger a decrease in the
domestic consumption of both country B's domestic and foreign goods, and therefore less demand
for its own currency. The elasticities approach is not problem-free because in the short term the
exchange rate is more inelastic than it is in the long term and additional exchange rate variables
arise continuously, changing the rules of the game.
 

These theories hold that the divergence between the exchange rate and the purchasing
power parity is due to the supply and demand for financial assets and the international capability.
One of the modern monetary theories states that exchange rate volatility is triggered by a onetime
domestic money supply increase, because this is assumed to raise expectations of higher future
monetary growth. The purchasing power parity theory is extended to include the capital markets.
If, in both countries whose currencies are exchanged, the demand for money is determined by the
level of domestic income and domestic interest rates, then a higher income increases demand for
transactions  balances while a higher interest rate increases the opportunity cost of holding
money, reducing the demand for money. Under a second approach, the exchange rate adjusts
instantaneously to maintain continuous interest rate parity, but only in the long run to
maintain PPP. Volatility  occurs because the  commodity markets adjust more slowly than the
financial markets. This version is known as the dynamic monetary approach.