Impact of NEER, REER, and inflation on exchange rates and trade
Question
With reference to the Indian economy, consider the following statements: Which of the above statements are correct?
- 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.
Options
1 and 2 only
2 and 3 only
1 and 3 only
1, 2 and 3
Explanation
Statement 1 is correct; an increase in NEER indicates that the domestic currency is appreciating against a weighted basket of foreign currencies. Statement 2 is incorrect; an increase in REER implies the currency is becoming relatively overvalued in real terms, which makes exports expensive and reduces trade competitiveness. Statement 3 is correct; REER adjusts NEER for relative inflation, so a persistent inflation gap naturally drives an increasing divergence between the two indices.
Answer: (c).
Question details
Year
2022
Paper
GS Paper 1
Question
Q2
Subject
Economy
Sub-topic
External Sector & Trade
Type
Statement-based
Difficulty
Hard
Nature
Static
Source hint
NCERT Economy Cl.12 / REER & NEER Indices
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