Question

Differentiate the nominal and real exchange rate between the dollars and euros. Do the two exchange rate move together? Why is appreciation or depreciation of real exchange rates important?

Answer 1

Nominal exchange rate describes the number of unit of a currency which can be exchanged for other currency while real exchange rate describes the number of units of a good which can be exchanged with foreign country good.

Real Exchange rate is calculated as: [Nominal Exchange Rate * (Domestic Price / Foreign Price)]

If there is no change in domestic as well as foreign price, nominal and real exchange rate move together.

Appreciation of real exchange rate means that more of foreign goods can be traded for same domestic goods. It will raise imports into the domestic economy and reduce exports. On the other hand, depreciation of real exchange rate will raise exports and reduce imports. Appreciation / Depreciation of real exchange rate help countries managing their trade balance.