Question

Q. With reference to the Exchange Rates in an economy, consider the following statements:

Which of the above given statements is/are correct?

• A. 1 and 2 only
• B. 1 only
• C. 2 and 3 only
• D. 1 and 3 only

Answer 1

The correct option is B 1 only

Explanation:

Statement 1 is correct: The price of one currency in terms of the other is known as the exchange rate. The Real Exchange Rate refers to the ratio of prices of goods in foreign markets to those of domestic markets. While the Real Effective Exchange Rate (REER) is the weighted average of nominal exchange rates adjusted for relative price differential between the domestic and foreign countries. The real exchange rate is often taken as a measure of a country’s international competitiveness.

Statement 2 is Incorrect: The Real Exchange Rate is the ratio between prices abroad to those at home, thus If the real exchange rate is equal to one, currencies are at purchasing power parity. This means that goods cost the same in two countries when measured in the same currency. The Real Exchange Rate is a measure of Purchasing Power Parity (PPP) of a country. The Real Effective Exchange Rate (REER) is the weighted average of nominal exchange rates adjusted for relative price differential between the domestic and foreign countries and is related to the purchasing power parity (PPP) hypothesis.

Statement 3 is incorrect: The nominal effective exchange rate (NEER) is an unadjusted weighted average rate at which one country’s currency exchanges for a basket of multiple foreign currencies. The nominal exchange rate is the amount of domestic currency needed to purchase foreign currency. The NEER may be adjusted to compensate for the inflation rate of the home country relative to the inflation rate of its trading partners. The resulting figure is the real effective exchange rate (REER). Unlike the relationships in a nominal exchange rate, NEER is not determined for each currency separately. Instead, one individual number, typically an index, expresses how a domestic currency’s value compares against multiple foreign currencies at once.