Question

During 1995, the Mexican peso exchange rate rose from 5.33 peso/$ to 7.64 peso/$. At the same time, US inflation was approximately 3% in contrast to Mexican inflation of about 48.7%.

a. By how much did the nominal value of the peso change during 1995?
b. By how much did the real value of the peso change over this period?

Answer 1

The nominal value of the peso changed by 2.31 peso/$ in 1995, while the real value change, after adjusting for different inflation rates in the US and Mexico, results in a calculation that considers the relative purchasing power of the currencies.

Step-by-step explanation:

The question pertains to the impact of inflation on currency exchange rates, focusing on the Mexican peso's nominal and real value changes in 1995. To solve part (a), we look at the change in the nominal exchange rate:

Nominal value change = 7.64 peso/$ - 5.33 peso/$ = 2.31 peso/$

To address part (b), the real exchange rate change takes into account the inflation rates in both the US and Mexico.

Real value change = (Nominal value change) / (1 + Mexican inflation) - (US inflation) = (2.31 peso/$) / (1 + 0.487) - 0.03

The nominal value of the peso decreased by 2.31 peso/$, while the real value takes into account the inflation differential between Mexico and the US, resulting in a different rate that factors in the purchasing power erosion due to inflation.