Exchange rates
(1) Nominal exchange
rate (E): the foreign currency value of a domestic currency.
Appreciation = a rise in the foreign-exchange value of domestic currency
Depreciation = a fall in the foreign-exchange value of domestic currency
| |
Currency per U.S. dollar |
|
| Currency |
1/1/99 |
4/1/99 |
Did $ appreciate (A)
or depreciate (D)? |
| British pound |
0.6087 |
0.6238 |
|
| Canadian dollar |
1.5315 |
1.4987 |
|
| French franc |
5.6213 |
6.0793 |
|
| German mark |
1.6761 |
1.8126 |
|
| Japanese yen |
113.30 |
120.55 |
|
| Swiss franc |
1.3723 |
1.4800 |
|
(2) Real exchange
rate (R): a country's price-level adjusted exchange rate.
The real exchange
rate compares the price of domestic products to the price of foreign products,
both expressed in a common currency.
The formula:
R = E·P/P*
where (1) E=the foreign
currency value of domestic currency, (2) P=the domestic-currency price
of domestic products, and (3) P*=the foreign-currency price of foreign
products.
Note that E·P tells you
the foreign-currency price of domestic products, so R tells you how expensive
domestic products are compared to foreign products, expressed in a common
currency.
Real appreciation can occur 3 ways: (1) nominal appreciation (+E), (2)
higher domestic prices (+P), and/or (3) lower foreign prices (-P*).
Example: suppose
the U.S. and Germany trade only beer (prices are per 6-pack):
| |
April |
May |
| E (Marks per $) |
2.0 |
2.5 |
| U.S.: Price of Budweiser (Bud) |
$3.00 |
$3.00 |
| Germany: Price of St. Pauli Girl (Spg) |
6 Mks |
10 Mks |
| |
|
|
| Option 1: compare prices in Marks: |
|
|
| P of Bud in Mks: |
|
|
| P of Bud / P of Spg: |
|
|
| |
|
|
| Option 2: compare prices in $: |
|
|
| P of Spg in $: |
|
|
| P of Bud / P of Spg: |
|
|
(1) Did the dollar experience nominal appreciation or
depreciation? ____________
(2) Did the dollar experience real appreciation
or depreciation? ____________
Notes:
(1) It doesn't matter which currency
you use to calculate R, as long as you use the same one to compare prices
of domestic and foreign products.
(2) The real exchange rate is the
key to a country's international competitiveness:
Real depreciation
(-R) => enhanced international competitiveness of domestic products;
Real appreciation
(+R) => reduced international competitiveness of domestic products.