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Absolute Purchasing Power Parity & Real Exchange Rates International Finance Brief Side Trip: Appreciation & Depreciation • When we say that a currency appreciates, we have to: 1. State relative to what other currency and 2. Express the exchange rate in appropriate terms • For example, Dollar appreciates 5% relative to the yen ¥100/$ this year • 105 ¥ ¥ −100 $ $ ¥ 100 $ = 5% We can express appreciation as: ¥/$ 𝑺𝟏 • ¥105/$ next year Price in yen of $1 rises 5% ¥/$ = 𝑺𝟎 (𝟏 + %𝐀𝐩𝐩𝐫 $) ¥105/$ = ¥100(1.05) Depreciation is just negative appreciation 2 Discussion: What is the yen doing when the dollar is appreciating? It’s depreciating! ……But not by 5%: 1 $ 100 ¥ 0.01 $ ¥ 1 $ 105 ¥ 0.00952381 $ ¥ $ $ −0.01 ¥ ¥ = −4.762% $ 0.01¥ 0.00952381 3 • In general, what is the yen doing when the dollar is appreciating? It’s depreciating! By how much is it depreciating? −%𝑨𝒑𝒑𝒓$ %𝑨𝒑𝒑𝒓¥ = 𝟏 + %𝑨𝒑𝒑𝒓$ 𝐴𝑝𝑝𝑟$ = +%5 %𝐴𝑝𝑝𝑟¥ = −0.05 = −4.762% 1.05 𝟏 %𝑨𝒑𝒑𝒓¥ = −𝟏 𝟏 + %𝑨𝒑𝒑𝒓$ 4 •

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