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Question 1

nominal EXR

Answer 1

tells you how much foreign currency you can obtain with one unit of the domestic currency

e_nom

Question 2

exchange rates are determined by

Answer 2

Under a flexible-exchange-rate system (determined by gov) or floating-exchange-rate system, exchange rates are determined by supply and demand and may change every day;

Question 3

flexible-exchange-rate system

Answer 3

exchange rates were determined by governments

→The exchange rates were fixed because the central banks in those countries offered to buy or sell the currencies at the fixed exchange rate

Question 4

The real exchange rate

i. If a country’s real exchange rate is rising

Answer 4

tells you how much of a foreign good you can get in exchange for one unit of a domestic good.

e=(e_nom P)/P_For

i. its goods are becoming more expensive relative to the goods of the other country.

Question 5

i. when e_nom falls,
ii. when e_nom rises

Answer 5

i. the domestic currency has undergone a nominal depreciation (or it has become weaker)
ii. the domestic currency has become stronger and has undergone a nominal appreciation.

Question 6

Purchasing Power Parity (“PPP”)

Answer 6

similar goods have the same price in terms of the same currency.

• Why? If there were no transportation costs, then everyone would buy goods where they were cheaper.

then, real exr = 1,

P=P_For/e_nom

• In reality (and shown via empirical evidence)

→Countries produce different goods

→Some goods aren’t traded (services like haircuts)

→Transportation costs

→Legal barriers to trade

§So, PPP may hold in long run but not in short run!

Question 7

i. relative PPP
ii. Nom app is due to ___

Answer 7

i. when real EXR does not change : ∆e/e=0

THEN, (∆e_nom)/e_nom =∆e/e+π_For-π

since nominal exchange-rate movements reflect only changes in inflation.

• works well in countries with high inflation rates to describe the exchange rate movement since movements in relative inflation rate in those countries are higher than the movements in real EX
• Accounting for differences in GDP per capita improves the accuracy of the PPP hypothesis.

ii. real appreciation or a lower rate of inflation than in the foreign country.

Question 8

The real exchange rate also affects a country’s net exports

Answer 8

• net exports are affected through the demand for goods
• net exports directly impact the export and import industries in the country which affects overall economic activity.
• primary channel through which business cycles and macroeconomic policy changes are transmitted internationally

A higher real EX means:

• foreign goods are cheap relative to domestic goods, so there is a high demand for foreign goods (in both countries).
• increases imports and reduces exports (net exports decline)

Question 9

J curve

Answer 9

assumes a time period long enough that the movements along the J curve are complete, so that

a real depreciation raises net exports and a real appreciation reduces net exports.

(real appreciation: a country will import and export the same amount of goods for a time, with lower relative prices on the foreign goods, thus increasing net exports.)