Nominal exchange rate

Nominal exchange rate
See also
Capital flow Inflation target Going price Currency Convertibility Money emission Currency crisis Monetary policy instruments Over-valued currency Inflation import

Nominal exchange rate is defined as the price of the currency of one country expressed in the currency of another country, excluding inflation. However, after taking it into account we are talking about the real exchange rate.

For example, if the exchange rate is 1 EURO = 4 PLN, German citizens may exchange 1 EURO for 4 PLN on the world market. Similarly, a Pole can exchange 4 PLN for 1 EURO.

Nominal exchange rate and market stability

In order to improve the stability of imports and exports, the determined exchange rate has been adapted to the needs of a custom made-basket of currencies than SDR, which may exceed the determination of the exchange rate against one currency or SDR. The main disadvantage of designing exchange rate patterns is their complexity and high data requirements.

„In a general equilibrium context, exchange rate stability alone cannot guarantee overall external and domestic stability. however, exchange rate stability affects broad macroeconomic stability, that is, the stability of the fundamental macroeconomics.” (Mr. Zubair Iqbal, Mr. S. Nuri Erbas, 1997, s.3).

SDR (Special Drawing Rights) is an international currency unit with a non-cash character. It is used only by:

1. Central banks of states
2. Financial institutions

Nominal effective exchange rate

„A nominal effective exchange rate index is the ratio of an index of a currency's period-average exchange rate to a weighted geometric average of exchange rates for currencies of selected countries and the euro area.” (World Bank, 2011, s. 257)

The nominal exchange rate during hyperinflation

„Hyperinflation - the high inflation that arises when a government turns to the printing press to pay for large amounts of government spending.” (N. Gregory Mankiw, Mark P. Taylor, 2006, s.652).

„When the supply of money starts growing quickly, the price level also takes off and [..] mark depreciates. When the money supply stabilizes, so does the price level and the exchange rate. [...] It leaves no doubt that there is a fundamental link among money, prices and the nominal exchange rate.” (N. Gregory Mankiw, Mark P. Taylor, 2006, s.652).

The theory of purchasing power parity

Under „the theory of purchasing power parity, the nominal exchange rate between the currencies of two countries must reflect the different price levels in those countries. A key implication of this theory is that nominal exchange rates change when price level change. [...], the price level in any country adjusts to bring the quantity of money supplied and the quantity of money demanded into balance. Because the nominal exchange rate depends on the price levels, it also depends on the money supply and money demand in each country.” (N. Gregory Mankiw, Mark P. Taylor,2006, s.651).

„When a central bank in any country increases the money supply and causes the price level to rise, it also causes that country's currency to depreciate relative to other currencies in the world.” (N. Gregory Mankiw, Mark P. Taylor,2006, s.651-652).

References

• Iqbal Z., Erbas S. N. (1997), External Stability Under Alternative Nominal Exchange Rate Anchors: An Application to the GGC Countries, International Monetary Fund, Washington
• Mankiw N. G., Taylor M. P. (2006), Economics, Thomson Learning, Bath, UK
• World Bank (2011), World Development Indicators 2011,the International Bank, Washington

Author: Łukasz Gil