With reference to the Indian economy, consider the following statements: 1. An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee. 2. An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness. 3. 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?

Question

YESPYQ · Accepted Answer

Correct answer: 1 and 3 only. Statement 1 is correct: The Nominal Effective Ex- change Rate (NEER) is an unadjusted weighted average rate at which a country’s currency exchanges for a basket of multi- ple foreign currencies. An increase in NEER signifies that the domestic currency has strengthened or appreciated relative to the selected basket of foreign currencies. An increase in NEER means that, on average, the rupee has become more valuable relative to those other currencies. It takes more of the foreign currencies to buy one unit of the rupee. Statement 2 is incorrect: Real Effective Exchange Rate (REER) is a measure of a country’s currency value relative to a basket of other currencies adjusted for inflation differentials. An increase in REER implies that the domestic currency has ap- preciated in real terms, making exports more expensive and im- ports cheaper. Consequently, a higher REER indicates a loss in trade competitiveness, not an improvement. Statement 3 is correct : If domestic inflation is higher than inflation in other countries, the REER will appreciate (be- come mor

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