MACRO ECONOMICS ASSIGNMENT
The topic of the assignment is “Exchange rates”. An exchange rate is the price of a nation’s currency in terms of another currency. It has two components: domestic currency and foreign currency. There are two types of quotation, that is Direct and Indirect quotation. In a direct quotation, the price of a unit of foreign currency is expressed in terms of the domestic currency. In an indirect quotation, the price of a unit of domestic currency is expressed in terms of the foreign currency. Exchange rates are quoted in values against the US dollar. However, exchange rates can also be quoted against another nation’s currency, which is known as a cross currency, or cross rate.
An Exchange rate is the price of a nation’s currency in terms of another currency. An exchange rate has a base currency and counter currency. In direct quotation, the foreign currency is the base currency and domestic currency is the counter currency. And in an Indirect quotation, it is just the opposite. Most of the exchange rates use foreign currency as the base currency.
Foreign trade involves the use of different national currencies. The Foreign Exchange Rate is the price of one currency in terms of another currency. The Foreign exchange rate is determined in the foreign exchange market, which is the market where different currencies are traded. We measure the foreign exchange rate € as the amount of foreign currency that can be bought with one unit of domestic currency .
e = foreign currency/domestic currency
A fall in the price of one currency in terms of one or all others is called depreciation. A rise in the price of a currency in terms of another currency is called an appreciation. And when a country lowers the official price of its currency in the market, this is called a devaluation. A revaluation occurs when the official foreign exchange rate is raised.
There are two types of exchange rates. They are Real exchange rate and Nominal exchange rate.
Nominal exchange rate are the relative price between domestic and foreign currencies. In Foreign exchange (FX) markets there are two types of nominal exchange rates notations.
Price notation, used by the US FED or Bank Of India, and many central banks.
Quantity(Indirect) notation, used by Bank Of England or European Central Bank.
*In the price notation, the foreign currency represents a good, and the exchange rate et is the price of the good. The relation of the movement of the exchange rate et and the value of INR is inverse.
*A decrease of the exchange rate et goes along with the appreciation of the INR.
*Both the notations are related inversely to each other.
Real Exchange Rate don’t measure the value of currencies, but the relative price of domestic and foreign currencies. They measure the real purchasing power of a country’s currency for given prices of representative baskets of goods and services.
Real exchange rate = Et * Pf / Pd
Where Et= Nominal exchange rate, Pf= price at foreign market, Pd= price at domestic market
In fixed exchange rate, governments specify the rate at which dollars will be converted into yen, pesos and other currencies. The most important fixed exchange rate is the Gold standard.
In flexible exchange rate or floating exchange rate, exchange rates are determined by demand and supply.
Indian Rupee per 1 US Dollar Graph
In the graph , it is seen that in the year 2018,the value of Indian rupees is diminishing and the value of US Dollar is Increasing. We can see that by November the value of US Dollar is increasing.
Hong Kong Dollar per 1 US Dollar Graph
Here it is seen that the graph is not stable. It is fluctuating .In January, the value of Hongkong dollar is less, but it is Increasing. During march to July it is somewhat showing a stable rate even though it is slightly increasing and decreasing. During September the value of US Dollar is decreasing. And by November it again increases.
Japanese Yen per 1 US Dollar Graph
The value of Japanese yen is decreasing in January. But in march it is growing. Then from may to November it is again decreasing at a slow pace.
Euro per 1 US Dollar Graph
In the above graph, the value of euro is decreasing when compared to US Dollar. In march the value of US dollar is declining. And from may to November the valueofUSDollarincreases.
The above graph shows the trends in Rupee Dollar exchange rate. We can see that as time passes the value of Indian Rupee is diminishing and the value of US Dollar is increasing. During 1970-1987 the value of INR is stable. And then it is fluctuating.
Exchange Rate Fluctuations and Trade Flows, Evidence from the European Union:- This paper showcases the effects of exchange rate volatility on bilateral trade flows. Through use of a gravity model and panel data from western Europe, the exchange rate uncertainty have a negative effect on international trade.
Do “Flexible” Exchange Rates of Developing Countries Behave Like the Floating Exchange Rates of Industrialized Countries?:- This paper is written by Peter Wickham, and it was published on may 1 2001. The paper examines the behavior of daily spot exchange rates for a sample of industrialized countries which are generally considered to be floating with only occasional official foreign exchange market intervention.
Sources of Nominal Exchange Rate Fluctuations in South Africa:- This paper was written by Jan Gottschalk ; Ashok Bhundia and it was published on December 1. It shows the sources of fluctuations in the U.S. dollar exchange rate in 2001 and 2002 using an exchange rate model which identifies aggregate supply, aggregate demand, and nominal disturbances as possible sources for exchange rate fluctuations.
Inflation Targeting and Exchange Rate Rules in an Open Economy:- This paper was written by Eric Parrado and it was published on February 1 2004. This paper shows a simple dynamic neo-Keynesian model is used to analyse the impact of monetary policy that considers inflation targeting in a small open economy. The economy is imperfect competition and short-run price rigidity. The findings of the paper are, depending on what affect the economy, the effects of inflation targeting on output and inflation volatility depend crucially on the exchange rate regime and the inflation index being targeted.
Real Exchange Rates in the Developing Countries: Concepts and Measurement:- This paper shows three important issues related to real exchange rates. Firstly , it discusses the analytical concept of real exchange rate. Second, paper deals with the problems associated with measuring real exchange rates. And the third, it analyses the actual behavior of RER’s in a number of developing countries.It also shows the real consequences of increased real exchange rate volatility.
Trade Liberalization and Real Exchange Rate Movement:- This paper is written by Xiangming Li and it was published on June 1 2003. The theory suggests that the real exchange rate depreciate after trade liberalization but could appreciate temporarily. This paper studies liberalization in 45 countries. The result shows that real exchange rates depreciate after countries open their economies to trade. In countries with multiple liberalization episodes, real exchange rates appreciate.
Exchange Rate Pass-Through to Domestic Prices : Does the Inflationary Environment Matter?:- This paper was written by Dalia S Hakura ; Ehsan U. Choudhri and it was published on December 1 2001. The paper tests a hypothesis by Taylor (2000) , a low inflationary environment leads to a low exchange rate to domestic prices. To test this, the paper finds a relation based on new open economy macroeconomic models.
Dread of Depreciation : Measuring Real Exchange Rate Interventions:- This paper was written by Jayasri Dutta and it was published on April 1 2002. We specify an empirical framework to detect the effects of official intervention on real exchange rate dynamics. Using data for 27 advanced and emerging market economies, we find evidence that interventions are a near-universal practice; almost all countries intervene when real exchange rates depreciate; interventions reduce the degree of persistence in real exchange rates; and the defense of an overvalued currency tends to be contractionary.
Explaining the Exchange Rate Pass-Through in Different Prices:- This paper was written by Hamid Faruqee ; Dalia S Hakura ; Ehsan U. Choudhri and was published in December 1 2002. This paper shows the performance of different new open economy macroeconomic models in explaining the exchange rate pass-through in a wide range of prices. The results show that the best-fitting model combines a number of features highlighted by different strands of the literature: sticky prices, sticky wages, distribution costs, and a combination of local and producer currency pricing.
The world has made a huge transition over the last 3 decades. During earlier periods, most of the currencies linked together in fixed exchange rates. Today except China all other countries have flexible exchange rate. This system has the disadvantage that exchange rates are volatile and can change from economic conditions. An exchange rate is the price of a nation’s currency in terms of another currency.
Economics- Paul A Samuelson , William D Nordhaus
World Development Indicators
International Monetary Fund(IMF)