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.
They include the monthly
nominal exchange rate, which is the ratio of domestic currency to foreign currency (Thai baht/U.S.
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 index.
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.
These results are in contrast with the findings of Thornton (1996) and Prock, Soydemir, and Abugri (2003) that M2 demand was a better monetary aggregate and that money demand in Mexico did not react to a shock to the
nominal exchange rate. The results in this study are consistent with the findings of Taylor (1993) and Rodriguez and Turner (2003) that there was currency substitution.
Furthermore, oil price shocks and
nominal exchange rate movements have been found to adversely affect stock market returns.
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).
