Answer to Question #311956 in Macroeconomics for xyouwf_

Question

Suppose China exports TVs and uses the yuan as its currency, whereas Russia exports vodka and uses the ruble. China has a stable money supply and slow, steady technological progress in TV production, while Russia has very rapid growth in the money supply and no technological progress in vodka production. On the basis of this information, what would you predict for the real exchange rate (measured as bottles of vodka per TV) and the nominal exchange rate (measured as rubles per yuan)? Explain your reasoning. (Hint : For the real exchange rate, think about the link between scarcity and relative prices.)

Answer 1

The real exchange rate measures the relative price of goods in two different countries. The real exchange rate is also known as terms of trade. The real exchange rate measured as bottles of vodka per TV drops as it going to take fewer bottles of vodka to buy one TV as vodka is relatively scarcer and TV is relatively abundant.

On the other hand, the Nominal exchange rate refers to the relative price of currencies of two different economies.

Nominal exchange rate (rubles per yuan) = real exchange rate(E)

the price level in Russia(P*)/ price level in China(P).

As stated it is clear that China has stable and slow money supply growth and while Russia is having a rapid growth in their money supply and as a result, the price level in Russia must be rising faster than the rise in the price level in China hence we can say that (P*/P) is rising but as seen real exchange rate is falling hence "E" is supposed to be decreasing and as result the change in the nominal exchange rate is ambiguous.