Economy2022
With reference to the Indian economy, consider the following statements:
- An increase in Nominal Effective Exchange Rate (NEER)
- An increase in the Real Effective Exchange Rate (REER)
- An increasing trend in domestic inflation relative
to inflation in other countries is likely to cause an increasing divergence between NEER and REER. Which of the statements are correct?
Explanation
The correct option is "1 and 3 only" because an increase in the Nominal Effective Exchange Rate (NEER) indeed signifies an appreciation of the domestic currency, such as the rupee, against a basket of other currencies. Conversely, an increase in the Real Effective Exchange Rate (REER) generally indicates a deterioration in trade competitiveness, as it reflects changes in price levels and inflation differentials between countries. Therefore, if domestic inflation rises relative to others, it would lead to a greater divergence between NEER and REER over time, as the nominal appreciation does not account for inflation adjustments that affect competitiveness.