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    Chap 18-2 PPT Presentation Group 8 (Macroeconomis)

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    Như Hảo
    The document outlines key concepts related to nominal and real exchange rates including: 1. Nominal exchange rates refer to the rate at which one currency can be traded for another, while real exchange rates refer to the rate at which goods and services can be traded between countries. 2. Purchasing power parity theory suggests nominal exchange rates should equalize the prices of goods between countries, such that a currency has the same purchasing power in all countries. 3. While PPP provides a simple model, it has limitations as some goods are not tradable and tradable goods may not be perfect substitutes between countries. Nominal exchange rates do not always perfectly reflect relative price levels.

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    © All Rights Reserved
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    Chap 18-2 PPT Presentation Group 8 (Macroeconomis)

    Uploaded by

    Như Hảo
    27 views25 pages
    The document outlines key concepts related to nominal and real exchange rates including: 1. Nominal exchange rates refer to the rate at which one currency can be traded for another, while real exchange rates refer to the rate at which goods and services can be traded between countries. 2. Purchasing power parity theory suggests nominal exchange rates should equalize the prices of goods between countries, such that a currency has the same purchasing power in all countries. 3. While PPP provides a simple model, it has limitations as some goods are not tradable and tradable goods may not be perfect substitutes between countries. Nominal exchange rates do not always perfectly reflect relative price levels.

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    Chap 18-2 ppt presentation group 8 (Macroeconomis)

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    The document outlines key concepts related to nominal and real exchange rates including: 1. Nominal exchange rates refer to the rate at which one currency can be traded for another, while real exchange rates refer to the rate at which goods and services can be traded between countries. 2. Purchasing power parity theory suggests nominal exchange rates should equalize the prices of goods between countries, such that a currency has the same purchasing power in all countries. 3. While PPP provides a simple model, it has limitations as some goods are not tradable and tradable goods may not be perfect substitutes between countries. Nominal exchange rates do not always perfectly reflect relative price levels.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    27 views25 pages

    Chap 18-2 PPT Presentation Group 8 (Macroeconomis)

    Uploaded by

    Như Hảo
    The document outlines key concepts related to nominal and real exchange rates including: 1. Nominal exchange rates refer to the rate at which one currency can be traded for another, while real exchange rates refer to the rate at which goods and services can be traded between countries. 2. Purchasing power parity theory suggests nominal exchange rates should equalize the prices of goods between countries, such that a currency has the same purchasing power in all countries. 3. While PPP provides a simple model, it has limitations as some goods are not tradable and tradable goods may not be perfect substitutes between countries. Nominal exchange rates do not always perfectly reflect relative price levels.

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    © All Rights Reserved
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    Download as pptx, pdf, or txt
    of 25

    The prices for International

    Transactions: Real and Nominal


    Exchange Rates
    Presenters:
    1. Nguyễn Hải Hà
    2. Vũ Thị Hạnh
    3. Phạm Thị Như Hảo
    4. Đoàn Thị Mai Ngọc
    OUTLINE
    1. Nominal Exchange Rates
    2. Real Exchange Rates
    3. A First Theory of Exchange- Rate Determination: Purchasing-
    Power Parity
    3.1. The Basic Logic of Purchasing- Power Parity
    3.2. Implications of Purchasing- Power Parity
    3.3. Limitations of Purchasing- Power Parity
    4. Conclusion
    Nominal exchange rate: the rate Real exchange rate: the rate at which
    at which a person can trade the a person can trade the goods and
    currency of one country for the services of one country for the goods
    currency of another. and services of another.

    Appreciation: an Purchasing-power
    increase in the value BASIC parity (PPP): a
    theory of exchange
    of a currency as
    measured by the
    amount of foreign
    CONCEPT rates whereby a
    unit of any given
    currency it can buy. currency should be
    Depreciation: a decrease in the able to buy the
    value of a currency as measured by same quantity of
    the amount of foreign currency it goods in all
    can buy. countries
    NOMINAL EXCHANGE RATES
    The Prices for International Transactions:

    Just as the price in any market serves the


    important role of coordinating buyers and sellers
    in that market, international prices help
    coordinate the decisions of consumers and
    producers as they interact in world markets.

    -> Here we discuss the two most important


    international prices: the nominal and real
    exchange rates
    What Is the Nominal Effective Exchange Rate (NEER)?

    The nominal exchange rate is the rate at which a


    person can trade the currency of one country for
    the currency of another.

    For example: When you go to a bank , you might see


    a posted exchange rate of 100 yen per dollar :
    • You give a bank 1 US dollar -> you will receive 100
    Japanese yen in return
    • You give a bank 100 Japanese yen -> you will
    receive 1 dollar
    Appreciation and depreciation
    • If the NER changes so that a dollar buys more foreign
    currency, that change is called an appreciation of the
    dollar.

    • If the NER changes so that a dollar buys less foreign


    currency, that changes is called an depreciation of the
    dollar.

    For example:
    - The NER rises from 100 to 110 per dollar
    -> the dollar is said to appreciation.
    - The NER falls from 100 to 90 per dollar
    -> the dollar is said to depreciation.
    What Does the Nominal Effective Exchange Rate (NEER) Tell You?

    • For example:

    • At time, the dollar is either


    strong or weak
    - When a currency appreciates, it is said to strengthen
    because it can then buy more foreign currency.
    - When a currency depreciate, it is said to weaken
    The Basket of Foreign Currencies

    • For any country, there are many


    nominal exchange rates. The US
    dollar can be use to buy Japanese
    yen, British pounds, Mexican pesos,
    and so on.
    REAL EXCHANGE RATES
    • 
    • Real Exchange Rate: the rate at which a person can trade the
    goods and services of one country for the goods and services of
    another.

    • Real Exchange Rate =

    RER =
    REAL EXCHANGE
    RATES
    • For
      example: The India VS Australia case, nominal exchange rate
    e = 50 Rupee/$ Price of a shirt:
    - 250 Rupees in India
    - 10 dollars in Australia
    Are you better off buying in India or in the Australia?

    Answer: RER =
    = 50 Rs/$ ($10/Rs 250)
    = 2 Indian shirts/1 AU shirt
     So shirts are in real terms, twice as expensive in the AU as they are in
    India.
    Overvalued exchange rate

    • An overvalued exchange rate is a situation when an exchange


    rate is higher that its fundamental value.
    Usually occurs in the fixed exchange rate system.
    • In a situation of an overvalued exchange rate a government can:
     devalue its nominal fixed exchange rate: bringing the official
    value into line with its fundamental value
     restrict international transactions: buy back its currency in
    foreign exchange market, in other words, the government
    becomes the demander of its own currency in the forex market
    (The most widely used approach).
    • To support the domestic currency the central bank must
    use the that correspond to the
    country's balance of payment
    deficit.

    • It cannot do that forever because


    the amount of reserves is limited.
    • At official exchange rate of 0.70 £/$
    is above the fundamental/market
    value The $ (against £) is overvalued
    • Excess supply of $ in the foreign
    exchange market: the length of AB
    • To keep the official exchange rate
    from falling down, the government could
    purchase a quantity of $ with £ in foreign exchange market equal to
    length of AB.
    PURCHASING-POWER
    PARITY
    • The theory of purchasing-power
    parity is based on a principle called
    the law of one price.
    • A good
    must sell for the same price in all locations.
    • A currency
    must have the same purchasing power
    in all countries.
    • Parity means equality, purchasing power refers to the value of money in
    terms of the quantity of goods it can buy.
    -> Purchasing-power parity states that a unit of a currency must have the
    same real value in every country.
    IMPLICATIONS OF
    PURCHASING-POWER
    PARITY
    • It tells us that the nominal exchange rate between the currencies of
    two countries depends on the price levels in those countries.

    • For example: If a pound of coffee costs 500 yen in Japan and $5 in


    US, then the nominal exchange rate must be 100 yen per dollar
    (500 yen/$5 = 100 yen per dollar)
    IMPLICATIONS OF PURCHASING-
    POWER PARITY
    Supposed that:
     P is the price of basket of goods in US (dollars)
     P* is the price of a basket of goods in Japan (yen)
     e is the nominal exchange rate. For the purchasing power of
    a dollar to be the same in two countries, it must be the case
    that:
     

    =
    IMPLICATIONS OF PURCHASING-
    POWER PARITY
    • With rearrangement, this equation becomes:
     
    1=

    In the case if the purchasing power of the dollar is always the


    same at home and aboard, then the real exchange rate- the
    relative price of domestic and foreign goods— cannot change.
    IMPLICATIONS OF PURCHASING-
    POWER PARITY
    • The nominal exchange rate equals the ratio of the foreign price
    level (measured in units of the foreign currency) to the domestic
    price level (measured in units of the domestic currency). That is,
    we can rearrange the last equation for the nominal exchange rate:
    e=P*/P
    The nominal exchange rate between the currency of two
    countries must reflect the price levels in those countries.
    • A key implication of this theory is that the nominal exchange rates
    change when price level changes or we can understand that when
    the central bank prints larger quantities of money, that money
    loses both in terms of the goods and services it can buy and in
    terms of other currencies it can buy
    LIMITATIONS OF PURCHASING-POWER PARITY
    Purchasing-power parity (PPP):
    provides a simple model of how
    exchange is determined and also
    explain the major changes in exchange
    rates that occur during hyperinflations.
    However, the theory of PPP
    is not completely accurate.

    There are two reasons the theory of PPP


    does not always hold in practice:
    Many goods are not easily traded.

    Even tradable goods are not always perfect substitutes when they
    are produced in different countries.
    LIMITATIONS OF PURCHASING-POWER PARITY
    • In some situations, are both because
    some goods are bot tradable and
    because some tradable goods are not
    perfect substitutes for their foreign
    counterparts, PPP is not a perfect
    theory of exchange rate determination.

    Nonetheless, PPP exchange rates


    fluctuate overtime.

    • As a result, large and persistent movements in


    nominal exchange rates typically reflect changes
    in price levels at home and abroad.
    An example of this is that the prices of Big Macs in some
    countries denominated in the local currencies.
    The nominal exchange rate -> the relative price of the currency of two
    CONCLUSION countries

    The real exchange rate -> the relative price of the goods and services of two
    countries

    Nominal & Real The nominal exchange rate changes so that each dollar buys more foreign
    exchange rate currency -> appreciate (strengthen)

    The nominal exchange rate changes so that each dollar buys less foreign
    currency -> depreciate (weaken)

    A dollar (or a unit of any other currency) should be able to buy the same
    quantities of goods in all countries

    The nominal exchange rate between the currencies of two countries should
    reflect the price levels in those countries
    Purchasing-
    power parity Country with relatively high inflation should have depreciating currencies

    Country with relatively low inflation should have appreciating currencies

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