Actual currency exchange rates

Real dollar exchange rate

The decision of the new government to unify the exchange rate resulted almost immediately in a depreciation of the Argentine peso. As expected, the measure had repercussions in the media and social networks, with a proliferation of opinion articles on the matter, both in favor and against the measure.
In this opportunity we will focus on answering 10 questions to understand what variables and facts impact on the determination of the exchange rate and, consequently, what are the effects to be expected from a devaluation. We will try to shed light on the issue in a simple way, seeking that our readers may improve their opinion, weighing the costs and benefits of the measure from a technical point of view, which -we hope- will serve as a complement to the subjective or ideological assessments of each citizen.
On the one hand, it will be seen that the path followed by the exchange rate in an economy depends on the -let us call it- invisible forces of the capitalist system and that, although there are many mechanisms to counteract them, it is not always easy to go against them. Secondly, it will become clear that, as with almost any economic policy action, the consequences can hardly be described in their entirety as «positive» or «negative».

Nominal exchange rate

Exchange rates and parities correspond to the terms of trade existing between two foreign currencies. Exchange rates refer to the amount of Chilean pesos per unit of foreign currency. Among these, the Observed Dollar (Chilean pesos per U.S. dollar), which corresponds to the weighted average price of transactions carried out by banking companies on the previous business day, stands out. This indicator is used by different agents as a reference for the valuation of assets and liabilities in foreign currency. Parities correspond to the amount in a currency of a given country that is equivalent to one U.S. dollar.
The Real Exchange Rate (RER) corresponds to the product of the observed nominal exchange rate and the external price index, deflated by the CPI. It is an index that measures Chile’s competitiveness with respect to its main trading partners, using for its calculation the evolution of the parities and inflation indexes of each of these countries.

Real exchange rate formula

The real exchange rate is the relative price of goods between different countries. It is usually defined as the ratio of the purchasing power of one currency relative to another currency. The purchasing power of a currency is the amount of goods that can be purchased with one unit of that currency. The purchasing power of a currency in a country depends on the price level. The purchasing power of a currency abroad depends on the nominal exchange rate and prices abroad.
Other definitions of the real exchange rate are based on the distinction between tradable and non-tradable goods. Tradable goods are those that can be traded freely between countries, such as books; while non-tradable goods are those that cannot be traded freely due to intrinsic issues, trade barriers or high transportation costs, such as a haircut at the hairdresser’s or a real estate. Assuming that the prices of tradable goods are the same all over the world, and Pt being the local price level of tradable goods and P*t the international price level of tradable goods, we assume that Pt = P*t.

Nominal exchange rate formula

In other words, the real exchange rate is a measure that indicates the purchasing power of one currency against another. Unlike the nominal exchange rate, it takes into account the prices in the country to which the currency belongs. To understand this, it is necessary to have a good understanding of several concepts. These concepts are defined in the following links:
In the financial markets currencies are quoted in the form of currency pairs. When we exchange one currency, we always exchange it in terms of another. For example, we have euros and we want to exchange into Argentine pesos. Or, we have US dollars and want Indonesian rupiah.
The ratio at which one currency is quoted against another is what is known as the nominal exchange rate. Continuing with the previous example, the nominal exchange rate answers the question: for each euro, how many Argentine pesos do I get? Or for each US dollar how many rupees will I get.
With the introduction to the key concepts we are ready to understand the concept of the real exchange rate. The real exchange rate, by taking into account the prices of two places with different currencies, adjusts the nominal exchange rate to the prices. Although we will see a numerical example later, a priori, several conclusions can be drawn.