Nominal exchange rate - What is it? causes of its variation, and more.

nominal exchange rate

The exchange rate refers to the price of one currency in terms of another.

What is the nominal exchange rate?

The nominal exchange rate is that exchange rate that refers to the price of one currency in terms of another. In this way it allows us to know what is the equivalence between two international currencies.

This concept is of great importance for international transactions since when you want to buy goods in another country, an exchange between different currencies is usually involved.

The nominal exchange rate can be the buying rate and the selling rate, the difference between the two is known as the " spread " and financial institutions make a profit based on this difference.

The nominal exchange rate is a price and therefore, as with other prices, its value changes due to factors of supply and demand. Let's see in more detail what can alter the nominal exchange rate.

Causes of the variation of the nominal exchange rate

The determinants of the nominal exchange rate can be divided into long-term and short-term determinants.

The long-term determinants are:

• The price level: An increase in the price level of the economy, relative to abroad, will cause the currency to depreciate; conversely, if the price level in the economy grows at a slower rate than abroad, the currency will appreciate. This occurs because the price level adjusts the imbalances between the two economies.
• Trade Barriers and Currency Demand – Usually represented as tariffs and quotas, they appreciate the currency of the country that imposes them because it can sell its products at a higher price. The increase in exports appreciates the currency and the increase in imports depreciates it, because the more national currency is demanded in the first and more foreign currency in the second.
• Productivity: an increase in productivity will make national products cheaper and their prices will decrease, becoming more attractive, thus increasing their demand and the currency appreciates.

The short-run determinants are:

• Interest rate: if the expected yield of the local currency is higher than the foreign one, its demand will increase, and therefore it will appreciate.
• Expectations: economic agents form expectations about the future value of the currency, that is, about its resale value.

Nominal and real exchange rate

Figures in economics can be expressed in both nominal and real terms. The main differences between these exchange rates are as follows:

• The nominal exchange rate refers to the face value, book value or expressed in monetary units, while the real value refers to the value deflated by inflation, that is, the one that takes into account the variation in the price level, therefore both the real value refers to the purchasing power.
• The nominal exchange rate expresses the rate at which the national currency is exchanged for foreign currency, while the real exchange rate expresses the rate at which goods are exchanged in the national market abroad.
• The nominal exchange rate can be easily found in the market and has a single value (except in cases of exchange controls with different schemes). On the other hand, the real exchange rate varies according to the basket of goods considered.

Nominal Exchange Rate Examples

The nominal exchange rate is expressed in pairs of currencies, therefore any currency market pair is an example of the nominal exchange rate.

Among these pairs we have:

• dollar/euro.
• dollar/pound sterling.
• yuan/dollar.
• Colombian peso/dollar.
• dollar / Argentine peso.

 

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