Real win over number can be defined as the rate that takes into mark inflation differential between the countries. Suppose the rupee was work at Rs 40 to a dollar at the setoff of 2009. Assuming a 10% inflation in the Indian miserliness and 5% inflation in the US economy for the whole year, then this model says the rupee should depreciate by 5% (10%-5%) to Rs 42 to a dollar, other things being equal.
why is the real exchange rate important?
Competitiveness of a countrys exports is decided not only by the nominal exchange rate, but also relative expense movements in interior(prenominal) and foreign markets. For instance, even if the nominal exchange of the rupee body unchanged with respect to, say, the dollar, Indias exports to the US will become slight competitive if inflation in India is higher than in the US. This mean nominal exchange rate will have to be correct for effect of inflation.
How is nominal exchange rate change for inflation?
Central banks use the concept of real effective exchange rate, or REER, to adjust nominal effective exchange rate for inflation. Conceptually, the REER is the weighted average of nominal exchange rate adjusted for the hurt differential between the domestic and foreign countries.
The price differential, however, is travelling bagd on the purchasing power concept. The currencies used be of those countries with which trade is the highest.
How does the RBI calculate REER?
The RBI calculates REER for India. It calculates the value of the rupee with respect to two indices, one comprising six countries and the other 36 countries with a 2004-05 base. The RBI, however, uses the wholesale price index-based inflation whereas globally consumer price indices are used. One conceptual flaw with this model is that it assumes that the base exchange rate is the correct exchange rate or represents the purchasing power parities accurately, which may not be the case.
What merely are nominal & real exchange rates?
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