Economics
Nominal Exchange Rate
The nominal exchange rate refers to the price of one country's currency in terms of another country's currency. It is the rate at which two currencies can be exchanged. This rate is often quoted in the foreign exchange market and is used for international trade and investment.
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9 Key excerpts on "Nominal Exchange Rate"
eBook - PDF- John E. Marthinsen(Author)
- 2020(Publication Date)
- De Gruyter(Publisher)
The variety of potential alternatives may seem bewildering and a bit disconcerting, but the purpose for calculating a meaningful effective exchange rate is the same, namely, to provide information on the average value of a na-tion ’ s currency. For the most part, reported effective exchange rates use trade flows as the basis for their weights. Nominal Versus Real Exchange Rates Newspapers, magazines, and television reports are filled with stories about ex-change rates and the economic effects of their movements. Most of these re-ports focus on Nominal Exchange Rates because they are highly visible. Nominal Exchange Rates are the ones quoted to customers by bank tellers and foreign exchange dealers around the world and the ones we use to translate foreign pri-ces into domestic prices. The problem with Nominal Exchange Rates is that they do not convey enough meaningful information to determine whether nations ’ international competitive positions have changed because they ignore the effects of relative international price differences. For this reason, serious economic and financial analyses usually focus on real exchange rates rather than nominal ones. The real exchange rate is calculated by adjusting the Nominal Exchange Rate for relative international price differences. For example, take two countries and two currencies, Country A with Currency A and Country B with Currency B. Their real exchange rate is equal to the Nominal Exchange Rate (NER), in terms of Currency B units per Currency A, times the domestic price (Currency A) of Country A ’ s tradable basket of goods and services, 2 divided by the domestic price (Currency B) of Country B ’ s tradable basket of goods and services (see Figure 16.2). Care must be taken whenever real exchange rates are calculated because the currency units used to measure the Nominal Exchange Rate and prices of tradable baskets must be aligned correctly for the real exchange rate to make sense.
eBook - PDF- John F. Bilson, Richard C. Marston, John F. Bilson, Richard C. Marston(Authors)
- 2007(Publication Date)
- University of Chicago Press(Publisher)
Nominal apprecia- tion of the exchange rate in the face of external price increases could also be consistent with private market behavior where agents perceive the de- terioration of the terms of trade as a permanent improvement in international competitiveness. More often, however, at least among smaller European countries, increases in foreign prices have been transmitted to domestic prices through substitution and income effects in consumption or production. This process could even be accompanied by exchange rate depreciation if the rise of internal prices exceeds that of traded goods.4 Finally, changes in Nominal Exchange Rates among hard currencies have led to changes in effec- tive exchange rates which have in turn been transmitted to domestic prices and, in the case of countries with market power, to the foreign currency price of export^.^ Thus real exchange rate movements reflect different economic processes which result from the interaction of private market participants and policy authorities. Even in those cases where real exchange rates have remained roughly constant, it is interesting to analyze the economic forces behind the process of real exchange rate determination. Such analysis can highlight the effectiveness of exchange rate policy and can illuminate the fundamental reasons for alternative targets in the exercise of exchange rate policy. Thus in a country where Nominal Exchange Rate devaluation quickly raises domes- tic prices by the full extent of the devaluation, an active exchange rate pol- icy can only become an instrument of anti-inflation policy rather than bal- ance of payments adjustment. Alternatively, if the speed of adjustment is low, Nominal Exchange Rate policy can potentially become a useful instru- ment of external balance.
eBook - ePub- (Author)
- 2023(Publication Date)
- Wiley(Publisher)
depreciating against the US dollar.These exchange rates are referred to as nominal exchange rates. In contrast, real exchange rates are indexes that often are constructed by economists and other market analysts to assess changes in the relative purchasing power of one currency compared with another. Creating these indexes requires adjusting the Nominal Exchange Rate by using the price levels in each country of the currency pair (hence the name “real exchange rates”) to compare the relative purchasing power between countries.In a world of homogenous goods and services, and with no market frictions or trade barriers, the relative purchasing power across countries would tend to equalize: Why would you pay more, in real terms, domestically for a “widget” if you could import an identical “widget” from overseas at a cheaper price? This basic concept is the intuition behind a theory known as purchasing power parity (PPP), which describes the long-term equilibrium of Nominal Exchange Rates. PPP asserts that nominal exchange rates adjust so that identical goods (or baskets of goods) will have the same price in different markets. Or, put differently, the purchasing power of different currencies is equalized for a standardized basket of goods.
eBook - ePub- Javier A. Reyes, W. Charles Sawyer(Authors)
- 2019(Publication Date)
- Routledge(Publisher)
In this section, we explain the concept of the real exchange rate. The real exchange rate is the Nominal Exchange Rate adjusted for changes in both domestic and foreign prices. As we will see, the real exchange rate is important in the context of Latin America. At times in the region, the Nominal Exchange Rate can be quite deceptive. An understanding of the real exchange rate is crucial in understanding the economic changes that have occurred in the region over the past several decades. To borrow a thought from Paul Samuelson, the real exchange rate is an important concept, but it is not obvious. To illustrate this, let’s consider a normal economic transaction. Suppose that last year you exchanged a dollar for 1,000 pesos and crossed the border and purchased a bottle of soda. Now, assume that prices in the US are constant and that the rate of inflation in RCILA is 100 percent. A year later, the same transaction might look something like this. You now exchange a dollar for the 2,000 pesos and cross the border and buy a bottle of soda. Notice what has occurred. The Nominal Exchange Rate has changed dramatically. However, a dollar still bought you a bottle of soda. Adjusted for inflation, the real exchange rate has not changed. Just a bit of consideration of this example illustrates how deceptive the Nominal Exchange Rate can be. The example may seem extreme, but, as we will see in Chapter 11, situations such as this were all too real in Latin America in the late twentieth century. To understand the real exchange rate requires some logic and arithmetic. The starting point is the law of one price. The law of one price is the simple statement that identical goods sold in competitive markets should cost the same everywhere when prices are expressed in terms of the same currency. The example above was an illustration. If a bottle of soda cost a dollar in the US, then it should also cost a dollar across the border. One’s first reaction may be that this is ridiculous
eBook - ePub- Anthony J. Makin(Author)
- 2016(Publication Date)
- Routledge(Publisher)
e↑). This suggests that the Nominal Exchange Rate is currently too strong and is therefore overvalued. On the contrary, ifthe Nominal Exchange Rate needs to appreciate to restore the PPP equilibrium. Hence, it is presently too weak relative to its long-run equilibrium value. So it is undervalued.The notions of undervaluation and overvaluation of the Nominal Exchange Rate relative to implied equilibrium exchange rate values are illustrated in Figure 3.4 . Note that when the local currency is undervalued, competitiveness temporarily improves, whereas competitiveness worsens when the local currency is overvalued.To recap, exchange rate changes alter the prices of domestically produced goods and services relative to goods and services produced in foreign economies. Hence, they affect the profitability of exporting and the cost of importing from abroad. Competitiveness either improves or worsens over the short term because of Nominal Exchange Rate movements or because domestic prices or costs change relative to prevailing prices or costs in major trading partners.FIGURE 3.4 Currency undervaluation and overvaluationSince Nominal Exchange Rates are far more variable than relative national price levels or relative labour costs, which influence price levels, sharp Nominal Exchange Rate swings account for most of the real exchange rate movements that occur over the short to medium term.KEY POINTS1. The exchange rate affects the prices at which a country trades with the rest of the world and is central to international monetary economics.2.
eBook - PDFA Concise Guide to Macroeconomics, Second Edition
What Managers, Executives, and Students Need to Know
- David Moss(Author)
- 2014(Publication Date)
- Harvard Business Review Press(Publisher)
Unfortunately, many business managers—particularly those with little experience in international markets—remain far more alert to changes in Nominal Exchange Rates than to changes in real exchange rates, even though the lat- ter may be every bit as important in determining the health and vitality of their firms. Money 53 We return to exchange rates in subsequent sections (and in chapter 7). But for now, it is worth noting how the nominal–real divide can affect the relationship between money growth, exchange rates, and the balance of trade. As already suggested, substantial money growth in a country is likely to cause the country’s Nominal Exchange Rate to depreciate. But substantial money growth can also spark domestic inflation, which can cause the real exchange rate to move in the other direction. The key question is whether domestic inflation is greater than exchange-rate depreciation—or, more precisely, whether the dif- ference between domestic and foreign inflation is larger than the depreciation of the domestic currency relative to the foreign cur- rency. If the inflation-rate differential (domestic minus foreign) exceeds the nominal rate of depreciation of the exchange rate, then the real exchange rate will appreciate, placing downward pressure on the balance of trade. If the inflation-rate differential is less than the nominal rate of depreciation of the exchange rate, then the real exchange rate will depreciate, placing upward pressure on the balance of trade. (See figure 2-4.) Increase in money supply Nominal Exchange Rate may depreciate Real exchange rate may depreciate Inflation may rise Real exchange rate may appreciate ? FIGURE 2-4 Money growth, inflation, and exchange rates (nominal versus real) Understanding the Macro Economy 54 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 Money Illusion and Sticky Wages In an ideal world, individuals would always be able to distinguish real economic changes from merely nominal ones.
- Colin Carter(Author)
- 2019(Publication Date)
- CRC Press(Publisher)
Using a nominal rate in such an equation is most likely a mismeasurement and may well lead to bias in the coefficients. In empirical work the foreign country is actually likely to be an aggregation of purchasers of U.S. goods. As indicated in Dutton and Grennes (1985), the exchange rate used is generally an index of exchange rates with a set of other countries. There are many possible mathematical forms for such an index. Unfortunately, neither the theory underlying the export equation above, nor other theory, reveals grounds for choosing one form over another. The Role of Exchange Rates 113 The Exchange Rate in a Four-Good Model A richer model would be one with an additional competitor good, available from a third country. This good is a fairly close substitute for the U.S. agricultural good, perhaps a differentiated version of the same good. The function is: ( * * * * *) X = f p A' p 0' p N' p C' y (8) * where PC is the price of the competing good in terms of the currency of the customer country. As before, zero degree homogeneity can be cited to justify conversion of all fmancial variables to dollars. Alternatively, one might want other equation forms. For example, the competitor price in dollars could be 0 0 replaced by (PC * E 0 ), where PC is the competitor price in competitor country currency and E 0 is the dollar-competitor currency exchange rate, expressed in dollars per unit of competitor currency. This form would justify including an exchange rate in the equation, even though all variables are nominal. To be properly specified the 0 equation should also contain PC If that term were omitted, the exchange rate would J>ick up its effects. Its coefficient and others would be biased if PC were correlated with the other variables. It is wise to remember that the measured exchange rate effect would represent the influence of a left out price variable.
eBook - PDF- Harms, Philipp(Authors)
- 2016(Publication Date)
- Mohr Siebeck(Publisher)
VIII.4.7 A Look at the Data In order to assess whether the monetary model offers a good explanation of observed Nominal Exchange Rates, we extend our framework by introducing a foreign economy F . Combining the foreign version of the money market equi-librium condition (8.27) with equations (8.25) – (8.28), we arrive at an expres-sion that describes the (fundamental) exchange rate in period t as (8.41) t s H s F s F s H s t t s t y y m m e E 1 1 1 The foreign price level and the foreign interest rate have vanished since they are now determined by the evolution of the money supply and of real GDP in country F . Using H s F s F s H s R s y y m m to denote the monetary fun-damentals in relative terms , we can show that the growth rate of the Nominal Exchange Rate is given by (8.42) 1 1 1 1 E 1 E 1 1 1 t s R s t R s t t s R t t t e e The evolution of t e thus mirrors both observed fundamentals and revised ex-pectations about the future (starting in period 1 t ). We assume that the funda-mentals follow a first-order autoregressive process: (8.43) 1 1 s R s R s ... , 1 , t t s with 1 0 and 0 E 1 s s . Substituting this expression into (8.42) yields (8.44) 1 1 1 1 R t R t t t e e The change of e is thus proportional to the change of R , with the factor of proportionality depending on the persistence of the autoregressive process that describes the evolution of monetary fundamentals ) ( . If R follows a random walk – i.e. if 1 – the exchange rate is as volatile as monetary fundamentals. 356 VIII The Nominal Exchange Rate Conversely, if the process in (8.43) is stationary ) 1 ( , the variance of ob-served depreciations and appreciations should be smaller than the variance of relative monetary fundamentals. Combined with the assumption that monetary fundamentals follow a linear first-order autoregressive process, the monetary model thus delivers two important hypotheses. – Nominal depreciations and appreciations should mirror changes of (relative) monetary fundamentals.
eBook - ePub- Miroslav Beblavý(Author)
- 2007(Publication Date)
- Taylor & Francis(Publisher)
Therefore, emphasis on the use of the exchange rate channel in the process of disinflation in advanced transition countries should not be automatically identified with a fixed Nominal Exchange Rate. To bring inflation down to EMU levels, Nominal Exchange Rate appreciation might be necessary. The speed of nominal appreciation tolerated or even encouraged by policy-makers depends on the desired speed of disinflation and also on the weight they put on the exchange rate in the disinflation process.Even though nominal appreciation is technically possible with a fixed exchange rate through revaluation, it is unlikely, particularly in countries with higher rates of inflation. For all countries but Hungary, a trend appreciation in the real exchange rate can be demonstrated for the 1993–2001 period, but the trend was extremely uneven during individual subperiods and the size of the trend differed significantly between countries. As there is a high level of uncertainty as to the sources as well as the size of the trend, it has been very difficult for policy-makers to accurately estimate an equilibrium real exchange rate. This has made them be reluctant to institute an official revaluation and prefer a more gradual mechanism afforded by a floating currency. Therefore, nominal appreciation was allowed by the authorities only under the floating regimes.3 On the other hand, it should be noted that the Nominal Exchange Rate can be and has been used as a tool of disinflation even when it was depreciating, but depreciating more slowly than the inflation differential would suggest.Therefore, priority ascribed to low inflation and to the role of the exchange rate in achieving it has been the first consideration of policy-makers in Central Europe in determining the exchange rate strategy. For a hypothetical strategy based solely on this consideration, achievement of low inflation primarily by stability or even appreciation of the Nominal Exchange Rate would be the exclusive priority.The second aspect of the exchange rate strategy is the priority placed on the achievement of nominal predictability, if not always stability, via exchange rate policy. If the exchange rate is to play the role of the nominal anchor, then it must be, to a large degree, stable and predictable, with a limited flexibility. If potential exchange rate fluctuations are significant in comparison with the inflation rate, economic agents can no longer rely on the Nominal Exchange Rate as the anchor for their expectations of price developments. On the other hand, an irrevocably fixed exchange rate with no flexibility (e.g. dollarisation) makes for a very strong nominal anchor. Exchange rate strategies have to place themselves on a continuum between the two extremes.
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