Lecture - Open Economy - Exchange Rate Dynamics
Lecture - Open Economy - Exchange Rate Dynamics
Exchange rate
Lecture
Section D, E and Pgp_Fin_03
and actors in the • Businesses are exposed to them when they purchase inputs to production
from other countries and enter contracts to export their goods and services
economy elsewhere.
Supply of
Dollars, S1
S2 Xr2*
R
XR*
Demand 0 Q*
for dollars
Quantity of net exports
Q*
Quantity of dollars
The supply and demand for INR increases; More inflows and demand for INR increases and no
outflow reducing the supply of INR:
Real exchange rate( adding prices)
A) Bilateral exchange rate
The currency of domestic country expressed in a foreign country currency
Gives an idea of the strength of my currency in the medium run to that country
currency.
B) Trade also is influenced by the cost of production ( Inflation in the economy)
Real exchange rate: Real cost of domestic currency in terms of foreign currency
27/06/2023 REER 17
REER: calculating using two components
NEER = (Foreign country A/Domestic country unit)ω * ( Foreign country B
/Domestic country ) ω
Relative price ratios weighted average = ( Domestic country price index/ Foreign
country A price index)ω *(Domestic country price index /Foriegn country B price
index) ω
Real Effective Exchange Rate = Nominal Effective Exchange Rate * Weighted
Average Relative Price Ratios
27/06/2023 Discussion 19
Increases in NEER can lead to similar increases in REER.
Domestic price levels in India being higher than those of countries part of
the trade basket.
The appreciation during the last few months can be attributed to increases
in the CPI, which have significantly pushed up the REER, notwithstanding
negligible increase in NEER
https://www.financialexpress.com/opinion/indias-export-competitiveness-is-devalua
tion-of-the-rupee-the-way-forward/381485/