Formula for Maintaining Competitiveness in Long-Run Equilibrium

Exchange Rate Behavior Between FlexIT Economies with Different Inflation Targets

A country is experiencing a domestic inflation rate of 5%, while its major trading partners have an average inflation rate of 2%. For this country to maintain a constant level of international competitiveness (i.e., a stable real exchange rate), what must happen to its nominal exchange rate?

Evaluating a Policy's Impact on Competitiveness

Assessing International Competitiveness Stability

A country's international competitiveness will remain stable if its nominal exchange rate appreciates at a rate exactly equal to the difference between its domestic inflation rate and the foreign inflation rate (domestic inflation minus foreign inflation).

To maintain a stable real exchange rate (constant international competitiveness), a specific relationship must hold between the nominal exchange rate and inflation rates. Match each nominal exchange rate scenario with the corresponding inflation condition required for this stability.

A country's currency is depreciating at a nominal rate of 3% per year. The domestic inflation rate is 7% per year. To ensure the country's international competitiveness remains unchanged (i.e., the real exchange rate is stable), the inflation rate in its trading partners must be approximately ______% per year.

Maintaining International Competitiveness

A country's central bank observes that its domestic inflation rate is persistently higher than that of its main trading partners. To prevent a loss of international competitiveness, the bank must manage its currency's value. Arrange the following steps in the logical order that describes the process of maintaining a stable real exchange rate in this scenario.

Analyzing Annual Changes in International Competitiveness

Evaluating an Economic Analyst's Claim on Competitiveness