True or False?
True! This can be seen from our definition of the real exchange rate in Equation 1.
Q = P / Π P*
When Π goes up, foreign currency costs more in terms of domestic currency and the value of domestic goods in terms of foreign goods, represented by Q , falls. Note that the right side of the equation measures the prices of domestic and foreign goods in domestic currency. This is why P* is multiplied by Π . Of course, we could have defined the nominal exchange rate as the price of domestic currency in terms of foreign currency, in which case the real and nominal exchange rates would always move in the same direction.