Engel - NOTES ON ACCOUNTING FOR U.S REAL EXCHANGE RATE CHANGES 1 TP PT HAKAN YILMAZKUDAY Engel(1999 defines the real exchange rate as a measure of

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1 NOTES ON ACCOUNTING FOR U.S. REAL EXCHANGE RATE CHANGES TP 1 PT HAKAN YILMAZKUDAY Engel (1999) defines the real exchange rate as a measure of one country’s overall price level relative to another country’s overall price. In order to show the derivation of an expression for real exchange rate, consider the following price index for the home country: ( ) N t T t t p p p α + = 1 (1) Here, t p is the log of the price index, T t p is the log of the traded-goods price index, N t p is the log of the nontraded-goods price index, and is the share that nontraded goods take in the price index. Thus, the price index for the home country is a geometric weighted average of traded- and nontraded-goods prices. Analogously, we can also write the price index of the foreign country, as follows: ( ) * * * 1 N t T t t p p p β + = (2) where is the share of nontraded goods in the foreign price index. By using Equations (1) and (2), we can define the real exchange rate as follows: TP 1 PT This paper draws on Engel (1999).
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2 t t t y x q + = (3) where t t t t p p s q + = * (4) T t T t t t p p s x + = * (5) ( ) ( ) T t N t T t N t t p p p p y = α β * * (6) Here, t s is the log of the domestic currency price of foreign currency. Equation (3) indicates that the log of the real exchange rate is composed of two parts: the relative price of traded goods between the countries,
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This note was uploaded on 01/11/2012 for the course ECO 601 taught by Professor Hakanyilmazkuday during the Fall '11 term at FIU.

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Engel - NOTES ON ACCOUNTING FOR U.S REAL EXCHANGE RATE CHANGES 1 TP PT HAKAN YILMAZKUDAY Engel(1999 defines the real exchange rate as a measure of

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