The Nominal Exchange Rate

1
The Nominal Exchange Rate

• Nominal exchange rate the rate at which one
  countrys currency trades for another
• We express all exchange rates as foreign currency
  per unit of domestic currency.
• Some exchange rates as of 6 Jan 2006, all per
  US
• Canadian dollar 1.16
• Euro 0.82
• Japanese yen 114.43
• Mexican peso 10.56

2
Appreciation and Depreciation

• Appreciation (or strengthening) an increase
  in the value of a currency as measured by the
  amount of foreign currency it can buy
• Depreciation (or weakening) a decrease in
  the value of a currency as measured by the
  amount of foreign currency it can buy
• Examples During 2005, the U.S. dollar
• appreciated 15 against the euro
• depreciated 5 against the Mexican peso

3
Relationship between Exchange Rate and Purchasing
Power

• Purchasing power of U.S. dollars can be different
  in a foreign country!
• Its not only determined by exchange rate, but
  also affected by price level in U.S. and Foreign
  countries.

4
Example With One Good

• A Big Mac costs 2.50 in U.S., 400 yen in Japan
• e 120 yen per Nominal Exchange Rate
• e x Pus price in yen of a U.S. Big Mac
• (120 yen per ) x (2.50 per Big Mac)
• 300 yen per U.S. Big Mac
• Compute the real exchange rate

0.75
5
Inflation Depreciation in a Cross-Section of
31 Countries
Avg annual depreciationrelative to US
dollar1993-2003 (log scale)
Avg annual CPI inflation 1993-2003 (log scale)