Real Effective Exchange Rate (REER)

Real Effective Exchange Rate (REER) is a measure of the trade-weighted average exchange rate of a currency against a basket of currencies after adjusting for inflation differentials with regard to the countries concerned and expressed as an index number relative to a base year.[1]

The nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) is measured with nominal parts, i.e. without taking into consideration the differences between the purchasing power of the two currencies, whereas the real effective exchange rate includes price indices and their trends.[2] The REER is NEER with price or labor cost inflation removed from it. A comparison of the REER of a number of countries can show which ones have gained and which ones have lost some of their international competitiveness.[3]

The nominal effective exchange rate allows defining the extent by which the exchange rate of the national currency changed relatively to exchange rates of the trading countries compared to a base year. However, the change in the nominal effective exchange rate does not reflect changes in the purchasing power of the currency, nor to what the extent the competitiveness of good produced in the country and showing an export potential changed during a specific period of time. In order to define the extent by which the purchasing power of the currency changed during some period of time, a real effective exchange rate is calculated.[4]

REER is also defined as the average of the bilateral Real Exchange Rates (RER) between the country and each of its trading partners, weighted by the respective trade shares of each partner. Being an average, the REER of a country can be said to be in equilibrium if it is found overvalued in relation to one or more trading partners whilst also being undervalued to the others.[5]

The trade shares of a country in each industry can be used to determine the weight each country should have in these calculations. This methodology can take into account both domestic and third-market effects. The Information Notice System (INS) of the IMF provides such weights for almost all countries, which are used extensively to calculate REERs. These weights are supposed to reflect the major competitors of the economy.[6]

Real Effective Exchange Rates are used for an array of purposes such as assessing the equilibrium value of a currency, the change in price or cost competitiveness, the drivers of trade flows, or incentives for reallocation production between the tradable and the non-tradable sectors. Due to the significance of the REER in economic research and policy analysis, multiple institutions including well-known bodies like the World Bank, the Eurostat, the Bank for International Settlements (BIS), the OCED, Bruegel and others publish various REER indicators for free public access. All these institutes combined publish data for 113 countries that contain all advanced and several emerging and developing countries. However, different databases have different methodologies, and even the 109 countries included in the World Bank database miss plenty of countries of the world.[7]

4. Balance of Payments of the Kyrgyz Republic for 2002 – National Bank of the Kyrgyz Republic
6. Real Effective Exchange Rate and the Constant Elasticity of Substitution Assumption by Antonio Spilimbergo and Athanasios Vamvakidis – IMF Working Paper 128 – July 2000


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