This graph suggests that the US moved toward a positive trade balance as the real exchange rate between the Euro area and the US decreased for US citizens.
Real exchange rate
B Y M I K E F L A D L I E NReal Exchange Rate
The Basics A consumer can buy anapple in the UnitedStates The apple costs $2 The exchange rate is $3for 1€ A consumer can buy anapple in the Euro area The apple costs 2 Euros The exchange rate is 1€for $3
What is the Real Exchange Rate?Real exchange rate is the cost of domestic goodsrelative to the cost of foreign If the consumer lives in the US and buys anapple, she will spend $2 If the consumer lives in the US and buys an applefrom the Euro area, then the apple will cost her $6($3 = 1€ and the apple costs 2€) Thus the US consumer “gave up” 3 apples The real exchange rate is 3 to 1
Real Exchange Rate For The Euro Area When the consumer in the Euro area buys an applein the US, she gives up 1/3 of an apple Thus, economics predicts that since apples arerelatively cheaper in the US, consumers in Europewill buy US apples
What Does the Data Suggest? At least, during the latest recession, the realexchange rate became more favorable for US citizens In other words, they had to give up less in domesticgoods to purchase foreign goods Euro buyers of US goods had to give up moreEuropean goods to buy US goods The trade balance should have moved to a positivebalance. Did it?
A Technical Definition This is from AmosWeb.com: EXCHANGE RATE: The price of the currency of one country stated in termsof the currency of another country, that is, the rate ofexchange of one currency for another. Exchange rates,also termed foreign exchange rates, are pricesdetermined in foreign exchange markets that are set upto trade the currencies of different nations (foreignexchange). In general, exchange rates reflect the overallhealth, vitality, and productivity of a nations economy.However, because exchange rates also affectinternational trade (exports and imports) among nationsthey are often subject to governmental policy control.
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