What Is the Real Effective Exchange Rate?

The real effective exchange rate is the weighted average of the bilateral nominal exchange rates of a country s currency and the currencies of all trading partner countries, excluding the effect of inflation on the purchasing power of each country s currency.

Real effective exchange rate

RMB

In the concrete empirical process, people usually distinguish effective exchange rate into nominal effective exchange rate and real effective exchange rate. A country's nominal effective exchange rate is equal to the weighted average of the bilateral nominal exchange rates of its currency and the currencies of all trading partner countries. If the influence of inflation on the purchasing power of each country's currency is excluded, the actual effective exchange rate can be obtained. The real effective exchange rate not only considers the relative changes in all bilateral nominal exchange rates, but also excludes the impact of inflation on the change in the value of the currency itself, which can comprehensively reflect the external value and relative purchasing power of the national currency.

At present, popular weighted average methods include arithmetic weighted average and geometric weighted average. When measuring the effective exchange rate, researchers often design their weighted average calculation methods, sample currency ranges, and trade weights and other related parameters based on their own special purposes. The results may differ to some extent.