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The IUP Journal of Applied Finance
Reexamining the Nexus Between Nominal and Real Effective Exchange Rates in India: An Application of Autoregressive Distributed Lag Model
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The study is an attempt to reexamine the relationship between nominal effective exchange rates and real effective exchange rates in India. The study investigates both long-run and short-run relationships between the two variables by using Autoregressive Distributed Lag (ARDL) bounds tests approach. The monthly data of the variables for the period January 1994 to August 2016 was considered for the study. The results of the ARDL tests reveal that there exists a long-run relationship between the real effective exchange rate and nominal effective exchange rate. The results of the error correction mechanism highlight that there exist short-run deviations in their relationship. Any deviation from the long-term nominal depreciation is corrected by 7.3% over each month for real depreciation at 5% level of significance.

 
 
 

Nominal exchange rate is the price of one currency in terms of number of units of some other currency. Nominal exchange rate is determined by the demand and supply of the two currencies in the foreign exchange market under a floating rate regime. It measures only the numerical exchange value of the two currencies and thus does not take into consideration the purchasing power of that currency. On the other hand, real exchange rates incorporate the purchasing power and competitiveness aspect and thus make the measure more meaningful.

The nominal and real effective exchange rates and the nominal and real exchange rates are not the same. Unlike the nominal and real exchange rate, the Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) are not determined for each foreign currency separately. In fact, NEER takes into consideration the overall nominal variation in the value of a country’s currency against the currencies of a basket of countries.

 
 
 

Applied Finance Journal, Reexamining the Nexus Between Nominal and Real Effective Exchange, An Application of Autoregressive Distributed Lag Model