Another test is based on the existence of cointegrating relationship between the log of nominal exchange rate
(or its percentage change) and the price level (or inflation rate) differential.
The revaluation of the central rate of the Irish pound in the run-up to EMU in the spring of 1998 also showed a readiness to adjust nominal exchange rates
when this is believed to contribute to macroeconomic stability.
Whether or not nominal exchange rates
eventually move in response to international inflation differentials is a topic of continued economic research and disagreement, but two aspects of the controversy seem to be settled: Deviations from this metric can persist for many years, if not decades, and such deviations are fully consistent with a well functioning foreign-exchange market.
Based on intervention and depreciation costs, this paper is able to rationalize the fact that emerging markets end up with higher inflation rates and lower fluctuations in the nominal exchange rate
as the outcome of an optimal policy decision.
These US monetary conditions reflect an exogenously imposed nominal yield curve (Figure 1) and an exogenous nominal exchange rate
growing at the same rate as a representative US trade weighted index (TWI) (Figure 3).
Thus, dollar depreciation (appreciation) is a positive (negative) change in the nominal exchange rate
In part 3, economic levers, refers to the nominal interest rate and nominal exchange rate
. They are the capital prices, which are not only indicators of the economy, but also influencers of the economy, just like levers in physics.
On the other hand, even after utilizing an IT framework, some agents may continue to perceive the exchange rate as a nominal anchor, that is, they may reshape their behaviors conditional upon the movements of the nominal exchange rates
. This importance may be attributed to (1) costs of imported inputs, (2) delays in the accommodation of economic agents to the new regime, (3) nominal exchange rate
being an easy-to-capture and well-packed daily market indicator, (4) uncertainty on a daily basis being mostly captured by the exchange rate dynamics, and (5) the presence of high dollarization.
A percentage change in Pakistan's real exchange rate equals the sum of: (i) the percentage change in the nominal exchange rate
(where a more depreciated nominal exchange rate
raises competitiveness); and (ii) the inflation rate differential between Pakistan and its trading partners (where a positive differential reduces competitiveness).