Describe what happens to the domestic real exchange rate and to trade flows in each of the following situations:

i) The domestic inflation is higher than foreign inflation and the domestic country has adopted a fixed exchange rate regime.

ii) The domestic nominal exchange rate is unchanged and domestic prices decrease faster than foreign prices.

iii) The domestic nominal exchange rate is unchanged and the domestic prices rise while foreign prices decrease.

iv) The domestic nominal exchange rate appreciates and domestic and foreign prices are unchanged.

v) The domestic nominal exchange rate depreciates and domestic prices rise faster than the depreciation rate while prices abroad are constant.

Transcribed Image Text:

Where Et is the nominal exchange rate, defined as the price of a unit of the domestic currency in terms of the foreign currency, is the domestic inflation rate and the foreign inflation rate. Where Et is the nominal exchange rate, defined as the price of a unit of the domestic currency in terms of the foreign currency, is the domestic inflation rate and the foreign inflation rate.

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