jnu-exchange rate q

[akanksha]

Suppose that the exchange rate of the Indian rupee appreciates by 10 percent relative to the currencies of India's trading partners..Over the same period, inflation in India is 8 percent compared to 3 % inflation in the trading partners.what is the change in India's exchange rate..?
a. 5 % APPRECIATION
B.10 % appreciation
c. 15  % appreciation
d.5 % depreciation.
i guess the ans. is a
bcz... acc. to krugman
 % change i real exchange rate = deviation from relative PPP
                                                = % change in  exchange rate - % change in prices
please try this out and confirm.. m not sure..

[Homer Simpson]

i think its (d) the questions says the "change" in exchange rate - the final effect would be 5% appreciation.

[Anjali]

I think c
Because when we take deviation in PPP , that accounts for the change in real exch rate
-10-(8-3) = -15 %

[The Villain]

Its a..a high rate if infn in 1 country relative to another puts pressure on er and there is general tendency for currency in high infln country to depr.so overall change is 5%

[akanksha]

thanks a lot everybody
 my  real doubt is
in sum books
 percentage change in REAL exchange rate=% change change in exchange rate + 
                                                                       % change in prices of the economies

whreas, in krugman    
percentage change in REAL exchange rate=% change change in exchange rate  -
                                                                       % change in prices of the economies

so what is the correct formula..which one should i adopt..

[Anjali]

Ron Iam not really convinced . Could you elaborate your working ?

[Akshay Jain]

http://books.google.co.in/books?id=Ej5Rc_bZIrEC&printsec=frontcover&source=gbs_ge_summary_r&cad=0#v=onepage&q&f=false

@akanksha...hav a look at chapter 5 "the trade balance and exchange rates" of this book....read pages 131-132(derivation of real ex rate) and 145-147(PPP theory)

[Anjali]

Akshay could you plz explain this ques's ans ?

[Homer Simpson]

[Akshay Jain]

Acc to me its option d
%dep in ER = domestic inflation - foreign inflation
= 5%

[Anjali]

Then what is 10% appreciation here ?

[Homer Simpson]

basically, there was 10% appreciation before, now we have a 5% inflation differential which means there will be a 5% depreciation and the net result is a 5% appreciation. so in terms of change, 5% depreciation is the answer.

[Akshay Jain]

Tsuki....

[Siddhant]

tsuki wrote

basically, there was 10% appreciation before, now we have a 5% inflation differential which means there will be a 5% depreciation and the net result is a 5% appreciation. so in terms of change, 5% depreciation is the answer.

Net result is 5% appreciation, so answer is (a) right?

[akanksha]

@ akshay..
i could not find those pages in the above mentioned link..
i would be really thankful  if u could explain the concept along withe ans..thanks

[Akshay Jain]

let the real EX rate be Q = no. of domestic goods per unit of foreign goods (Indian good/US goods),
Nominal Ex rate be E=rupees/dollar (say),
Domestic price level Be Pd (rupees) and
Foriegn price level be Pf (dollars)
by defination of real ex rate
Q=E*Pf/Pd
= (rupees/Dolar)*(Dollar/US goods)/(rupees/domestic goods)
= Domestic goods/US goods
take logs both sides and then take total differential
dQ/Q = dE/E + dPf/Pf - dPd/Pd
if we take Q as a constant den dQ/Q=0 (relative PPP)
dE/E=dPd/Pd - dPf/Pf
%dep of domestic currency=domestic inflation-foreign inflation
the question asks for the change in the nominal Ex rate and not the real EX rate
we are given dat dE/E=-10%
and the inflation differential is 8-3=5%DEP OF EX rate
so it depreciates E by 5%(option D)
the end result is dat we will hav an appreciated domestic currency by 5%

[Anjali]

So Akshay you mean that it changes by 5% (dep) and changes to -5% ( app ) . Is that so ?

[akanksha]

thanku so much akshay..i got it
what if the ques asked about change in real exchange rate ?