Nominal vs. Real Exchange Rates Quiz
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Questions and Answers

What does an increase in the nominal exchange rate (E) represent when quoted as USD per AUD?

  • Decrease in the import demand from Australia
  • Depreciation of the AUD against the USD
  • Appreciation of the AUD against the USD (correct)
  • Increase in the value of USD in the market

    • What is the primary effect of fixed exchange rates on monetary policy?

  • Limits the ability to respond to economic fluctuations (correct)
  • Makes monetary policy irrelevant for international trade
  • Increases effectiveness at stabilizing domestic demand
  • Encourages higher interest rates in domestic markets

    • How is the real exchange rate (RER) calculated?

  • Using only domestic price levels and foreign price levels
  • By comparing nominal exchange rates across multiple currencies
  • Through the ratio of export prices to import prices
  • By adjusting nominal exchange rates by domestic and foreign price levels (correct)

    • When is a currency said to appreciate in real terms?

    <p>When RER increases above 1</p> Signup and view all the answers

    Which of the following best describes nominal exchange rates?

    <p>They are the relative price of one currency in terms of another</p> Signup and view all the answers

    What effect do expected changes in exchange rates have on international capital flows?

    <p>They connect interest rates across countries</p> Signup and view all the answers

    What does it indicate when RER < 1?

    <p>Foreign goods are more expensive</p> Signup and view all the answers

    Which method is typically used to quote nominal exchange rates?

    <p>Indirect quote only</p> Signup and view all the answers

    What effect does a decrease in the real exchange rate (RER) have on imports and exports?

    <p>Increases exports and decreases imports</p> Signup and view all the answers

    Which of the following statements about exchange rate regimes is correct?

    <p>Policy-makers set the price of a currency in a fixed exchange rate regime.</p> Signup and view all the answers

    What is a primary risk associated with a fixed exchange rate regime?

    <p>It can collapse if reserves are exhausted.</p> Signup and view all the answers

    How can the real exchange rate (RER) adjust even when the nominal exchange rate is fixed?

    <p>Via changes in relative price levels.</p> Signup and view all the answers

    What formula represents the change in real exchange rate (gRER)?

    <p>gRER = gE + gP - gP f</p> Signup and view all the answers

    What is the Law of One Price primarily concerned with?

    <p>How tradeable goods should sell for the same price everywhere.</p> Signup and view all the answers

    Which statement accurately reflects the implications of currency fluctuations under a floating exchange rate?

    <p>Market forces determine the currency value without intervention.</p> Signup and view all the answers

    What happens to net exports when the real exchange rate is depreciated?

    <p>Net exports increase due to decreased foreign goods.</p> Signup and view all the answers

    What primarily drives the supply of domestic currency in the foreign exchange market?

    <p>Domestic households and firms wanting to buy foreign currency</p> Signup and view all the answers

    Which factor contributes to an increased demand for domestic currency?

    <p>Higher real returns locally</p> Signup and view all the answers

    What occurs at the equilibrium nominal exchange rate?

    <p>Supply of currency equals demand</p> Signup and view all the answers

    Which of the following can shift the demand for foreign currency?

    <p>Rising tourist activity abroad</p> Signup and view all the answers

    What is a typical reason for higher demand for foreign goods and services?

    <p>Changing tastes of consumers</p> Signup and view all the answers

    What does an increased demand for foreign assets generally indicate?

    <p>Higher real returns abroad</p> Signup and view all the answers

    What can cause a shift in the supply curve for a currency in the foreign exchange market?

    <p>Changing economic policies at home</p> Signup and view all the answers

    What is the best explanation for the connection between nominal and real exchange rates?

    <p>Nominal exchange rates adjust to reflect changes in real rates</p> Signup and view all the answers

    What does the purchasing power parity (PPP) hypothesis suggest about real purchasing power between two countries?

    <p>Real purchasing power is the same if Absolute PPP holds.</p> Signup and view all the answers

    In what scenario does a domestic currency appreciate according to Relative PPP?

    <p>When foreign inflation is greater than domestic inflation.</p> Signup and view all the answers

    Which equation represents the relationship where the nominal exchange rate remains constant under Relative PPP?

    <p>gE = π f - π</p> Signup and view all the answers

    What does Absolute PPP imply about the relationship between nominal and real exchange rates in the long run?

    <p>Real exchange rates are approximately constant.</p> Signup and view all the answers

    If both countries experience high inflation, which statement is correct regarding Absolute and Relative PPP?

    <p>Relative PPP must hold if Absolute PPP holds.</p> Signup and view all the answers

    In which condition does the real exchange rate typically show less volatility?

    <p>With a fixed nominal exchange rate.</p> Signup and view all the answers

    How does the real exchange rate change in the short run according to the provided content?

    <p>It is predominantly influenced by shifts in the nominal exchange rate.</p> Signup and view all the answers

    What is indicated by a condition where the nominal exchange rate (E) suggests real economic stability?

    <p>Nominal exchange rate dynamics are closely co-movement with the real rate.</p> Signup and view all the answers

    Study Notes

    Nominal vs. Real Exchange Rates

    • The nominal exchange rate is the price of one currency in relation to another.
    • The direct quote refers to the domestic currency per unit of foreign currency.
    • The indirect quote refers to the foreign currency per unit of domestic currency.
    • An appreciation of a currency means its value is increasing, while depreciation signifies its value is decreasing.
    • The real exchange rate takes into account the relative prices of consumption baskets in different countries.
    • When the real exchange rate is greater than 1, foreign goods appear cheaper.
    • A lower real exchange rate (less than 1) implies foreign goods seem expensive.
    • Changes in the real exchange rate can occur due to changes in the nominal exchange rate or differences in price levels.

    Exchange Rate Regimes

    • Exchange rate regimes refer to the way a country chooses to manage its currency value.
    • A floating exchange rate is determined by market forces (supply and demand for the currency).
    • Fixed exchange rates are set by policy-makers.
    • A currency union represents a strong form of a fixed exchange rate.
    • A fixed exchange rate regime requires a central bank to buy or sell foreign currencies to maintain the fixed value.

    Purchasing Power Parity (PPP)

    • The Law of One Price states that tradeable goods should have the same price globally when converted to a common currency.
    • Absolute PPP suggests that the law of one price holds for all goods in a basket.
    • Relative PPP focuses on the changes in real exchange rates, implying they are driven by inflation differentials.
    • PPP serves as a good indicator of long-run exchange rate dynamics, especially for countries with high inflation.
    • PPP is less reliable for short-run exchange rate forecasting, particularly for low-inflation countries.

    Exchange Rate Determination in the Short Run: Supply and Demand

    • Currency exchange occurs in foreign exchange markets.
    • The supply of a domestic currency is driven by demand for foreign goods, services, and assets by domestic residents.
    • The demand for a domestic currency comes from foreigners' desire to purchase domestic goods, services, and assets.
    • The equilibrium exchange rate is where the supply and demand for a currency intersect.
    • Changes in trade patterns, tastes, interest rate differentials, or risk perceptions can shift the supply and demand curves for a currency.

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    Related Documents

    Introductory Macroeconomics Lecture 19: Exchange Rates I PDF

    Description

    Test your understanding of nominal and real exchange rates with this quiz. Discover the nuances of direct and indirect quotes, currency appreciation and depreciation, and the differences between floating and fixed exchange rate systems. Challenge your knowledge on how these concepts affect international trade.

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