Nominal Exchange Rate
The nominal exchange rate is the rate at which one currency can be exchanged for another in the foreign exchange market, without adjustment for differences in price levels. It is the rate actually quoted and traded in currency markets.[1]
Definition
The nominal exchange rate expresses the price of one currency in terms of another. If one unit of currency A can be exchanged for two units of currency B, the nominal exchange rate between them is two. The nominal rate can be quoted in either direction, so conventions matter when interpreting data.[1]
Nominal versus real
| Concept | Description |
|---|---|
| Nominal exchange rate | The rate at which currencies trade, unadjusted for prices. |
| Real Exchange Rate | The nominal rate adjusted for relative price levels. |
Whereas the nominal exchange rate reflects only the market price of currencies, the real exchange rate captures the relative purchasing power of two currencies with respect to goods and services, and therefore provides a better measure of competitiveness.[1]
Determination
Under floating exchange rates, the nominal rate is determined by supply and demand in the foreign exchange market, influenced by trade and capital flows, interest rate differentials, inflation differentials, and expectations about future policy. Short-run movements in the nominal rate can be large and volatile, often driven by financial flows rather than trade flows.[1]