How are the nominal and real exchange rate related?
Also, statement ‘changes in interest can cause flows of capital. But they cannot affect the real exchange rate’
- nominal exchange rate is the price of foreign currency, in this market
- real exchange rate is defined as the relative price of foreign goods in terms of domestic goods. It depends on the nominal exchange rate, the domestic price level and the foreign price level.
- changes in interest rates across countries generates flows of capital. This affects the nominal exchange rate which affects the real exchange rate which affects exports and imports.
- real exchange rate is comparison between prices whereas nominal is rate between currency
Uncovered interest parity condition
- it directly relates interest rate with nominal exchange rate and indirectly with imports and exports
- in particular, changes in the interest rate in the in the domestic and foreign countries cause capital flows ( this is recorded in the capital account of the balance of payment)
- these capital flows affect the nominal exchange rate
- and this causes changes in the real exchange rate which affects exports and imports (this is recorded in the current account)
Briefly explain the concept of circular flow of income
- shows how real resources and financial payments flow between firms and households
- it is used to obtain a measure of economic activity and AD
- it is the concept that spending and income continue to circulate around the macroeconomy
- allows us to compute GDP using either the expenditure approach or the income approach
- it is a strategy used to analyse aggregate economy?
Asses the following statement and explain whether you agree or disagree with it.
‘According to the Solow Model, population growth rate is higher than food production growth rate’
This is the Malthusian perspective.
Malthus suggested economic growth is not sustainable because population increases exponentially but food increases arithmetically.
GDP per capita has increased along with population increase
GDP per capita has increased as time passes
In general economic growth has been positive, except in period of recession
Economic growth is higher in developing countries
In the long run Kaldor found:
- output per worker grows at roughly constant rate that does not diminish over time
- capital per worker grows over time
- the capital/output ratio is roughly constant
- the rate of return to capital is constant
- the share of capital and labour in net income are nearly constant
- real wage grows over time
Solution from R. Solow who developed model:
- grow comes from adding more capital and labour inputs and also from ideas and new technology
- the solos model believes that a sustained rise in capital investment increases the growth rate only temporarily because the ratio of capital to labour goes up.
- Solow model is a model expressed in terms of key variables per capita
- slow model based on 2 equations: an vestment equation and a saving equation.
- steady state means that key variable are growing at a constant rate