Being an economics student, I have been engrossed in various topics of macroeconomics for quite some time now. A lot of sources were referred to for topics like forex market, exchange rates and purchasing power parity. Assignments on the topics also accompanied the course curriculum. Luckily I came across nominal v/s effective rate help homework that cleared a lot of my doubts on exchange rate concepts.
Need for standards in forex market
If you see the scenario of the current world, you notice that all countries have sophisticated trade relations with different countries. Even if countries follow their own financial systems, they require to engage in international dealings while importing or exporting goods and services from and to partner countries.
Currencies are the most essential medium of transaction between countries while trading. As different countries have their own currency, international trading requires regulation of currency exchange rates and standards. Economists have over the years devised various indices to represent power of a countryâ€™s currency against the international standards. You must have used purchasing power parity a lot of times while working on the financial position of countries.
Purchasing power parity against effective rate
Read about different ways to represent financial position of countries and their currencies in nominal v/s effective rate help homework. Purchasing power parity and effective exchange rate are the most popular concepts in this matter.
Suggested by economists and international financial institutions, investors and traders worldwide follow different standards of currency exchange rate. Market conditions are studied while defining these figures in international trading.
As a country usually deals in trade with multiple other countries, you will be frequently hearing the term effective exchange rate. It is an index that determines how powerful the countryâ€™s currency is in comparison to a group of currencies of other countries. The group of currencies is usually taken from a countryâ€™s most important trading partners.
Nominal effective exchange rate
I found accounts of different ways to calculate effective exchange rate in nominal v/s effective rate help homework depending on market indicators.
One way of depicting exchange rate is the nominal effective exchange rate. It is a weighted average of bilateral exchange rates of home currency relative to currencies of other countries.There is no international standard for selecting the number of countries for calculation of the index. A common practice is to take into account a countryâ€™s most important trading partners.
Nominal effective exchange rate represents the external competitiveness of a country. It also can be considered as the purchasing power of the currency. The index compares the home currency with those of its trading partners as a weighted average.
When you consider a bilateral trade relation between two countries you analyze the currency pair of the two countries. Effective exchange rate maps the power of a countryâ€™s currency to multiple other currencies at the same time.
Effective rate in real world
As you read through the notes in nominal v/s effective rate help homework,you also read about the real effective exchange rate. It is common in real world economics to witness factors like price inflation and labor cost inflation in international trade. These factors influence the import and export values of any country.
Traders, investors, and analysts take into account inflation rate differences of partner countries into the nominal effective exchange rate and obtain what is called real effective exchange rate.
Real effective exchange rate is an average of bilateral real effective exchange rates with partner countries including trade factors of every partner.
Inclusion of inflation values and allocating required weights to each value is important to capture the influence of real time scenario on exchange rates. Real effective exchange rate actually represents the external competitiveness of a country.
Currencies for calculation are opted from those of the most important trade partners of the country. Most countries follow guidelines set by the International Monetary Fund for this purpose. The adjusted values are weighted according to the trade value of the partner country. The value may be import and export value, or the total value of import and export conducted with the trading partner.
Importance of effective rate in financial analysis
Modern macroeconomics sees the similar reference to effective exchange rate and the purchasing power parity for comparing currencies of countries.Â Both tools are widely used in international trade.
You need to note that import-export factor is included while calculating real effective exchange rate. A higher real effective exchange rate indicates higher export prices and reduced import prices. This means the financial power of a countryâ€™s currency goes down as compared to partner countries.
Nominal v/s effective rate help homework conforms to the views of economists and analysts that tools like nominal effective exchange rate and real effective exchange rate are important indicators of a countryâ€™s financial condition.Owing to frequently changing selling and buying power of countries, effective exchange rates also change rapidly over short periods of time.
Effective rates have a significant role to play in financial analyses and policy framing in all countries. The tool is a fair indicator of a countryâ€™s financial competitiveness in international market.
Nominal v/s effective rate help homework throws more light on financial parity regulation.