Suppose China exports TVs and uses the yeah as its currency, whereas Russia expo

Question

Suppose China exports TVs and uses the yeah as its currency, whereas Russia exports vodka and uses the ruble. China has a stable money supply and slow, steady technological progress in TV production, while Russia has very rapid growth in the money supply and no technological progress in vodka production. Based on this information, what would you predict for the real exchange rate (measured as bottles of vodka per TV) and the nominal exchange rate (measured as rubles per yuan)? Explain your reasoning.
(Hint: For the real exchange rate, think about the link between scarcity and relative prices.)

Explanation / Answer

With steady technological progress in making TVs, it becomes cheaper for China to make them. With no progress in vodka production in Russia, the price stays the same. The real exchange rate measured in terms of bottles of vodka per TV would be high but decreasing over time since it takes more resources to make TVs than a bottle of vodka, but the amount of resources for TV production are decreasing as a result of technological progress. The nominal exchange rate would be high and increasing. The supply of yuan is stable, especially relative to the rapidly increasing supply of rubles, so as the supply of rubles increase, it takes more to purchase one yuan.

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