Question

Suppose the world is made up of four countries: The US, England, and Japan and China. The trade weights, that is, the percent of trade that the US conducts with each country is below: England 20% Japan 30% China 50% Suppose that the $ US appreciates by 10% against the Japanese Yen, depreciates by 10% against the English pound, and depreciates by 2% against the Chinese Yuan. Calculate the percent change in the effective exchange rate.

Answer 1

Solution:

Effective Exchange rate (EER) = $\prod (si)^{wi}$ , where si refers to the exchange rate of US with country i, and wi refers to the share of volume of trade of US with country i.

So, percent change in exchange rate =  $\sum$wi*(%∆si)

= 0.3*(+0.1) + 0.2*(-0.1) + 0.5*(-0.02)

= 0.03 - 0.02 - 0.01

= 0

So, there is no change (or 0 percentage change) in the effective exchange rate.