On what is real exchange rate dependent?
For unlimited access to Homework Help, a Homework+ subscription is required.
The real exchange rate approach to exchange rate determination is based on q$ = R$ * PEU PUS or R$= q$ * PUS PEU
a) Given PUS = 115, PEU = 105, and R$ = $1.35 per euro, compute the real exchange rate. (5 pts)
b) Explain what the computed real exchange rate means. (5 pts)
c) From the above-mentioned real exchange approach, write an equation to show a formula for the percent change in the nominal exchange rate. (5 pts)
d) Using the formula that you wrote in (c), predict the percent change in the nominal exchange rate R$ in a year if the annual percent changes for PUS, PEU, and q$ are 5%, 10%, and 1%, respectively. (5 pts)
e) From the results of (d), explain whether a home currency ($) appreciates against a foreign currency in both nominal and real terms. (10 pts)
Suppose China exports TVs and uses the yuan as its currency, whereas Russia exports vodka and uses the ruble. China has a stable money supply and slow, steady technological progress in TV production, while Russia has very rapid growth in the money supply and no technological progress in vodka production. Based on this information, what would you predict for the real exchange rate (measured as bottles of vodka per TV) and the nominal exchange rate (measured as rubles per yuan)? Explain.
Sidenote: I was confused whether to use real exchange rate = nominal * (Prices in China/Prices in Russia) or real exchange rate = vodka bottles/TV
Sidenote: I was confused whether to use nominal exchange rate = real exchange rate * (Prices in Russia/Prices in China) or nominal exchange rate = Ruble/Yuan
Ā