The foreign exchange market is a special market in which foreign exchange transactions are carried out, i.e. exchange of currency of one country for the currency of another country at a certain nominal exchange rate.
The nominal exchange (exchange) exchange rate is the relative price of the currencies of the two countries, or the currency of one country, expressed in the monetary units of another country. When the term “currency rate” is used, we are talking about a nominal exchange rate.
The establishment of the national currency exchange rate in foreign currency is currently called currency quotation. Course a national currency can be defined as in the form of a direct quote when a foreign currency is accepted as a unit (for example, 2180 Belarusian rubles for 1 US $), and in the form of a reverse (indirect) quote, when a national currency is accepted as a unit (reverse quotation is used mainly in the UK and for a number of currencies in the United States). The use of reverse quotation allows you to compare the exchange rate of the national currency with foreign currencies in any foreign exchange market.
When the unit price of foreign currency in national currency units increases, they talk about the depreciation (deforestation) of the national currency. Conversely, when the unit price of foreign currency in national currency units falls, they talk about the cost of national currency.
The real exchange rate characterizes the ratio in which goods of one country can be sold in exchange for goods of another country.
In general terms, the real exchange rate characterizes the ratio of prices for goods abroad and in a given country, expressed in one currency. Those. the real exchange rate is the relative price of goods produced in two countries.
The real exchange rate R is defined as:
,
where e is the nominal exchange rate;
P * – price level abroad in foreign currency;
P is the level of domestic prices in national currency.
The real exchange rate assesses the country’s competitiveness in world markets for goods and services. An increase in this indicator, or a real impairment, means that goods and services abroad have become relatively more expensive, and therefore consumers both domestically and abroad will prefer domestic goods to foreign ones. The decrease in this indicator, or the real rise in price, on the contrary, indicates that the goods and services of a given country have become relatively more expensive, and it is losing competitiveness.
There are other approaches to assessing the real exchange rate. It can be defined as the ratio of prices of goods suitable for international exchange (tradables), which includes agricultural products, oil, automobiles, industrial equipment, etc., to the price of goods, non-international trade (nontradables), which includes construction and most services.
,
where e is the nominal exchange rate;
Pt – the price of goods suitable for international exchange (in foreign currency);
Pn is the price of goods that are not objects of international trade (in national currency).
This indicator also evaluates the country’s international competitiveness. The decrease in R, or the real rise in price, reflects the increase in domestic costs in the production of goods suitable for international exchange.
Sometimes R is defined as the ratio of labor costs in a unit of production abroad to this indicator within the country:
,
where e is the nominal exchange rate;
W * – unit costs for labor abroad (in foreign currency);
W – unit costs for wages within the country (in national currency). The higher this indicator, the cheaper the production of goods within the country and higher the competitiveness.
Empirical evidence of international differences in price levels denominated in one currency indicates a positive dependence of price levels on real per capita income. In other words, the purchasing power of a dollar convertible into the national currency of a country at the market exchange rate, the higher the lower the level of per capita income in that country.
The lower price level in underdeveloped countries is explained by the lower price level for goods not suitable for international trade (Pn), compared with the prices of goods that are objects of international trade (ePt). The reason for this phenomenon is the low level of labor productivity in underdeveloped countries. While prices for goods suitable for international trade are approximately the same in all countries, the lower level of labor productivity in industries producing goods suitable for international trade in underdeveloped countries, explains the low level of wages in these sectors, lower production costs in industries that produce goods that are not suitable for international trade, and, consequently, lower prices in these sectors.
As countries develop economically, the ratio of labor-capital in favor of the latter changes, primarily in industries producing goods suitable for international trade, the maximum labor productivity and, consequently, the level of wages increase. Labor and capital are moving away from labor-surplus industries that produce goods that are not suitable for international trade in more modern and productive industries that produce goods that are objects of international trade. The supply of goods suitable for international trade is falling, prices are rising for them, and, consequently, the overall price level in the country. Thus, as real per capita income grows, the national currency becomes real more expensive.