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With reference to the Indian economy, consider the following statements:
- An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee.
- An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.
- An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER.
How many of the above statements are correct?
- a)Only one
- b)Only two
- c)All three
- d)None
Correct answer is option 'B'. Can you explain this answer?
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Most Upvoted Answer
With reference to the Indian economy, consider the following statement...
- Statement 1 is correct: The nominal effective exchange rate (NEER) is an unadjusted weighted average rate at which one country’s currency exchanges for a basket of multiple foreign currencies. The nominal exchange rate is the amount of domestic currency needed to purchase foreign currency. If a domestic currency increases against a basket of other currencies inside a floating exchange rate regime, NEER is said to appreciate. If the domestic currency falls against the basket, the NEER depreciates.
- Statement 2 is not correct. An increase in REER means that the country’s currency has appreciated not only in nominal terms but also adjusted for inflation. This could actually make exports more expensive and imports cheaper, potentially reducing trade competitiveness.
- Statement 3 is true. If domestic inflation is higher than inflation in other countries, it would lead to a higher increase in the nominal exchange rate (NEER) compared to the real exchange rate (REER), leading to a divergence between the two.
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With reference to the Indian economy, consider the following statement...
Understanding NEER and REER in the Indian Economy
To evaluate the correctness of the statements regarding Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER), let’s break them down:
Statement 1: Increase in NEER indicates appreciation of rupee
- This statement is correct.
- NEER reflects the value of a currency against a basket of other currencies. An increase in NEER signifies that the rupee has appreciated relative to other currencies.
Statement 2: Increase in REER indicates improvement in trade competitiveness
- This statement is incorrect.
- REER accounts for inflation differences between countries. An increase in REER suggests that a country's goods are becoming more expensive relative to those of other countries, thus reducing trade competitiveness.
Statement 3: Increasing domestic inflation relative to other countries causes divergence between NEER and REER
- This statement is correct.
- If domestic inflation rises faster than inflation in trading partner countries, NEER may remain stable or even appreciate, while REER will decline. This divergence reflects a loss of competitiveness due to relatively higher domestic prices.
Conclusion
- Two statements (1 and 3) are correct while one (2) is not. Therefore, the correct answer is option 'B', indicating that only two statements are correct.
Understanding these nuances is crucial for analyzing currency dynamics and their impact on trade and the economy.
To evaluate the correctness of the statements regarding Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER), let’s break them down:
Statement 1: Increase in NEER indicates appreciation of rupee
- This statement is correct.
- NEER reflects the value of a currency against a basket of other currencies. An increase in NEER signifies that the rupee has appreciated relative to other currencies.
Statement 2: Increase in REER indicates improvement in trade competitiveness
- This statement is incorrect.
- REER accounts for inflation differences between countries. An increase in REER suggests that a country's goods are becoming more expensive relative to those of other countries, thus reducing trade competitiveness.
Statement 3: Increasing domestic inflation relative to other countries causes divergence between NEER and REER
- This statement is correct.
- If domestic inflation rises faster than inflation in trading partner countries, NEER may remain stable or even appreciate, while REER will decline. This divergence reflects a loss of competitiveness due to relatively higher domestic prices.
Conclusion
- Two statements (1 and 3) are correct while one (2) is not. Therefore, the correct answer is option 'B', indicating that only two statements are correct.
Understanding these nuances is crucial for analyzing currency dynamics and their impact on trade and the economy.
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With reference to the Indian economy, consider the following statements: An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee. An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness. An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER.How many of the above statements are correct?a)Only oneb)Only twoc)All threed)NoneCorrect answer is option 'B'. Can you explain this answer?
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