are these two comments correct or incorrect? 1) The real exchange rate of GBP per one USD can be interpreted as the UK real GDP per one unit of US real GDP. 2) The US balance of payments contains the official settlement accounts which show the changes in the government’s holding of foreign currencies. If the holding decrease, then the official settlements account balance would be positive.
not v sure about first one. maybe correct 2nd statement is correct
thanks. can you explain to me why the account balance would be positive? I thought it would be negative.
yeah this is counter-intuitive but just remember ‘follow the cash’. CA + KA + OSA = 0. So say CA decreases 100 (i.e. net 100 cash has flowed out) and KA has increased 50 (i.e. net 50 has flowed in). Since 100 has flowed out and only 50 flowed in, the gov’t holdings of foreign currency will have to fall by 50. But if we plug in the -100 CA and +50 KA into the equation above, OSA has to be negative 50 to get it to balance. Hope this helps.
It wont let me edit… anyway, the mistake was hopefully obvious and I’ve fixed it up below. yeah this is counter-intuitive but just remember ‘follow the cash’. CA + KA + OSA = 0. So say CA decreases 100 (i.e. net 100 cash has flowed out) and KA has increased 50 (i.e. net 50 has flowed in). Since 100 has flowed out and only 50 flowed in, the gov’t holdings of foreign currency will have to fall by 50. But if we plug in the -100 CA and +50 KA into the equation above, OSA has to be +50 to get it to balance. Hope this helps.
To answer the first question, the real FX rate is based on the nominal FX rate and the price levels in both countries. Not sure if the real GDP amounts for each country can be substituted for the price levels. In the formula below I use direct quotations. So your example of “GBP per one USD” would be USD:GBP meaning that it’s from the perspective of a UK investor. FX(real) = FX(nominal) x (price level foreign country / price level domestic country) So say that USD:GBP = 0.60 pounds and that the price level in the UK was 100 and in the US it was 200, then we calculate FX real as FX(real) = 0.60 x (200/100) = 1.2 pounds
I haven’t seen these two topics covered in notes. Thanks, guys. 