Lecture 4 Real exchange rates

Question 1

What is the real exchange rate?

Answer 1

the nominal exchange rate adjusted for relative prices

measure the extent to which nominal currency appreciation or depreciation has been offset by relative inflation rates

can be viewed as a measure of purchasing power in international markets, or of a country’s competitiveness.

It is real exchange rates that matter for trade competitiveness and, ultimately, growth

Question 2

A country’s bilateral real exchange rate can change if:

Answer 2

(1) Its nominal exchange rate changes;

(2) relative prices change; or both.

Question 3

If the dollar rises relative to the peso and relative prices remain unchanged a dollar, when exchanged for pesos, will buy more or less goods?

Answer 3

more Argentine goods.

This is because the appreciation of the dollar means that it is worth more pesos than before. Therefore, when you exchange dollars for pesos, you receive more pesos for each dollar. Assuming the prices of goods in pesos have not changed, you can now buy more goods with the same amount of dollars because you are using more pesos to make purchases.

Question 4

if U.S. prices rise relative to Argentine prices, with the exchange rate unchanged, the same goods are cheaper or more expensive in Argentina?

Answer 4

are now relatively cheaper in Argentina. Buy more!

Essentially, as U.S. prices increase while Argentine prices remain the same or increase less significantly, and with the exchange rate holding steady, the purchasing power shifts in favor of buying goods in Argentina for both Argentines and foreigners exchanging their currency.