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Exchange Rates, Business Cycles, and Macroeconomic Policy in the Open…
Exchange Rates, Business Cycles, and Macroeconomic Policy in the Open Economy
Nominal exchange rates
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For example, if the nominal exchange rate is 90 yen per dollar, one dollar can be exchanged for 90 yen
Denote the nominal exchange rate (or simply, exchange rate) as enom in units of the foreign currency per unit of domestic currency
Under a flexible-exchange-rate system or floating-exchange-rate system, exchange rates are determined by supply and demand and may change every day; this is the current system for major currencies
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Real exchange rates
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If the nominal exchange rate is 80 yen per dollar, and it costs 800 yen to buy a hamburger in Tokyo compared to 2 dollars in New York, the price of a U.S. hamburger relative to a Japanese hamburger is 0.2 Japanese hamburgers per U.S. hamburger
If a country’s real exchange rate is rising, its goods are becoming more expensive relative to the goods of the other country
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Fixed Exchange Rates
The government sets the exchange rate, perhaps in agreement with other countries
When the official rate is above its fundamental value, the currency is said to be overvalued
The country could devalue the currency, reducing the official rate to the fundamental value
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