Question

1. At the start of the year, the exchange rate was $1.285/€. At the end of the year, the exchange rate is $1.346/€. If U.S. inflation was 6% and European inflation was 3%, what has been the nominal and real change in the value of the Euro (versus the USD)?
2. what has happened to European export industry competitiveness over the year? (improved or worsened)

Answer 1

At the start of year, 1 Euro = $ 1.285

At the end of year, 1 Euro = $ 1.346

Therefore Euro has appreciated in nominal terms

% appreciation in nominal terms = value at the end of year / value at the beginning of year - 1

% appreciation in nominal terms = 1.346 / 1.285 - 1 = 4.747%

As per purchasing power parity Currency with lower inflation rate appreciates.

Interest rate in Europe = 3%

Interest rate in US = 6%

% appreciation in Europe = (1 + inflation in US) / (1 + inflation in Europe) - 1

% appreciation in Europe (due to inflation) = (1+6%) / (1+3%) - 1 = 2.913%

Therefore appreciation in real terms = (1+nominal increase) / (1+increase due to inflation) - 1

Appreciation in real terms = (1+4.747%) / (1+2.913%) - 1 = 1.782%

European export industry competitiveness over the year has worsened.

Exporters suffer due to appreciation of currency and importers gain from currency appreciation

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