November 24, 2010

Using the nominal exchange rate as a proxy for the real exchange rate carries with it the implicit assumption that the inflation rate or domestic prices have not offset the exchange rate fluctuations. That may be true some of the times and not true at other times. While we concede that adjusting the exchange rate for the cost of living may be additional work, we have to question the use of a proxy that may or may not give the correct answer at all times.

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