The Real Effective Exchange Rate

A currency's exchange rate against a single peer, like the dollar, only tells you part of the story: a country might be stable against the dollar while losing competitiveness against the dozens of other countries it actually trades with. The nominal effective exchange rate (NEER) fixes the first-order problem by weighting a currency's movement against a basket of its trading partners, using each partner's share of trade as the weight, so a currency's biggest trading relationships dominate the index rather than whichever pair happens to be quoted most often.

The real effective exchange rate (REER) goes one step further and adjusts that basket for relative inflation. If a country's prices rise faster than its trading partners', its goods become less competitive even if the nominal exchange rate hasn't moved, and REER captures that erosion by inflating or deflating each bilateral rate by the two countries' relative price levels before combining them into the index.

A REER reading is normally expressed as an index relative to a base period, so a REER of 110 means a currency is, on a trade- and inflation-adjusted basis, about 10% stronger than in the base year — a signal used to flag over- or undervaluation and to explain shifts in a country's trade balance that a single bilateral exchange rate would miss entirely.