International trade 2

Suppose, the nominal interest rate is 0.3 EURO/PLN. You want to sell goods worth 6000PLN. How much are they worth in Germany (in EURO)?

Real exchange rate is

• the relative price of domestic goods in terms of foreign goods

• a price of a currency in terms of another currency

• depends on nominal exchange rate

• depends on prices of goods and services in both countries

Suppose, the same model of a phone costs 1600 PLN in Poland and 250 EURO in France. The nominal exchange rate is 0.25 EURO/PLN.

• The real exchange rate is 6.4 PLN/EURO.

• The real exchange rate is 1.6.

• To buy the phone in Poland, someone would have to pay an amount that could buy 1.6 telephones in France.

• The phone is more expensive in France than in Poland.

When real exchange rate increases then

• the export will fall.

• the import will decrease.

• the net export will rise.

The real exchange rate

• impact the net export.

• ensures that there is an equilibrium in the foreign exchange market.

• impacts the demand for the domestic currency.

• impact the level of savings.

Fiscal policy at home. Suppose, the goverment introduces a policy, which aims at rising national savings. It will result in

• fall of the capital outflow.

• rise of the net export.

• fall of the real exchange rate.

Lets denote by  $e$  and  $\epsilon$  the nominal and real interest rate, respectively. The level of domestic prices is $P_d$ , whereas  $P_f$  is the level of foreign prices. Then 

•  $e=\epsilon\frac{P_d}{P_f}$  

•  $\epsilon=e\frac{P_d}{P_f}$  

•  $\%\Delta e=\%\Delta\epsilon\ +\ \pi_{f\ }-\pi_d$ , where  $\pi_{d\ }$  and  $\pi_f$  are domestic and foreign inflations and  $\%\Delta$  means a precentage growth rate.

 Suppose, the real interest rate increases by 3%, the domestic inflation is 4% and the foreign inflation is 2%. How much will the nominal exchange rate change? 
 $\%\Delta e=\%\Delta\epsilon\ +\ \pi_{f\ }-\pi_d$  

• 1%

• 2%

• 3%

• 4%

Suppose, the nominal interest rate rises by 5%, the domestic inflation is 2% and the foreign inflation is 4%. How much will the real exchange rate change?
 $\%\Delta\epsilon\ =\%\Delta e\ -\ \pi_{f\ }+\pi_d$  

• 2%

• 3%

• 4%

• 5%

Purchasing Power Parity (PPP) assumes that

• the real and the nominal interest rates are the same.

• the real exchange rate equals 1 ( $\epsilon=1$ )

• the nominal exchange ratebetween two countries equals the ratio of thecountries’ price levels.