The real exchange rate nominal exchange rate adjusted

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The Real Exchange Rate Nominal exchange rate adjusted for diferences in prices or inlaion. Is a measure of the purchasing power of the currencies in foreign markets. Relevant for measuring compeiiveness of the economy. Rise in nominal exchange rate and/or rise in the price level erode the compeiiveness of a country’s economy. The Real Efecive Exchange Rate A combinaion of 2. and 3. Problem of trade weights now compounded by problem of price indexes (consumer price index, Distributing prohibited | Downloaded by K C ([email protected]) lOMoARcPSD|2330446
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wholesale price index, GDP delator or other). Used to measure value of a speciic currency in relaion to another group of currencies and shows what can actually be purchased with that currency. Value an individual consumer pays for an imported good at the consumer level. Important measure when assessing trade capabiliies and current trade situaion. Can be used to measure equilibrium value, idenify underlying factors of trade low, look at changes in internaional price or cost compeiion and allocate incenives between tradeable and non- tradeable sectors. Country can posiively afect through producivity growth, which returns lower costs and lower prices. 1. Introducion: the purpose of models and an overview of exchange-rate models Derived demand – We do not demand currency for its own sake, but to buy foreign goods Demand curves are negaively sloped Supply curves posiively sloped Assumpions: One foreign currency, ER measured in a direct way Notaion: S(d/f), Qf, Df, Sf, Equilibrium: Where supply = demand, equals price, when not at equilibrium price will be bid up or down Changes in exchange rate when one of the curves changes S(f/d) = demand and supply would slope opposite ways Comparaive staics – compare two outcomes ater change in underlying parameter, parameters underlying curves are exogenous variables Variables entered into a model – exogenous – price of a Ferrari etc. (inlaion) Endogenous variables determined inside the model – ER, consumpion, income etc. One exogenous variable change generally changes all endogenous variables, only change one to know where the change came from Df = Qm x P*m = total value of imports Sf = Qx x P*x Qm = a-b(Pm) Pm = SP*m Qx = c-d(P*m) P*x – Px/S % Change in Qm = elasicity of imports imes % price change in imports in domesic terms % Change in Qx = elasicity of exports imes % price change in exports in foreign terms Factors afecing supply and demand Relaive inlaion rates If domesic inlaion is higher than foreign, domesic goods will become more expensive than foreign goods, leading to increase in demand for foreign goods and decline in demand for Distributing prohibited | Downloaded by K C ([email protected]) lOMoARcPSD|2330446
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domesic goods. This means an increase in demand for foreign and decrease in supply of foreign currency. Shit in demand curve to right and shit in supply curve to let (domesic depreciaion) Relaive interest rates If domesic rises relaive to foreign, domesic inancial assets become more atracive than foreign inancial assets, this results in capital lows into domesic assets. Decrease in demand for
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