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Bilateral exchange rate involves a currency pair, while an effective exchange rate is a weighted average of a basket of foreign currencies, and it can be viewed as an overall measure of the country's external competitiveness. A nominal effective exchange rate (NEER) is weighted with the inverse of the asymptotic trade weights.
The trade-weighted effective exchange rate index is an economic indicator for comparing the exchange rate of a country against those of their major trading partners. By design, movements in the currencies of those trading partners with a greater share in an economy's exports and imports will have a greater effect on the effective exchange rate. [1]
The effective exchange rate index describes the strength of a currency relative to a basket of other currencies. Although typically the basket is trade weighted, there are others besides the trade-weighted effective exchange rate index. Ho (2012) proposed a new approach to compiling effective exchange rate indices.
The central bank said in a Jan. 17 report the real effective exchange rate, a measure used to approximate "fair value" of a currency, was 9% below its 10-year median.
Bilateral exchange rate involves a currency pair, while an effective exchange rate is a weighted average of a basket of foreign currencies, and it can be viewed as an overall measure of the country's external competitiveness. A nominal effective exchange rate (NEER) is weighted with the inverse of the asymptotic trade weights.
While still retaining the meaning of a unit of global real purchasing power, the WCU can now be interpreted as a GDP-weighted basket of currencies, each indexed against domestic inflation. The GDP-weighted basket of currencies has now formed the basis for a new formula for the effective exchange rate.
For example, if the inflation rate is 5%, on a one-year loan of $1,000 with an 8% nominal interest rate the real interest rate would be 8% minus 5% or 3%. The real interest rate will usually be ...
The real exchange rate is a more informative measure of the dollar's worth since it accounts for countries whose currencies experience differing rates of inflation from that of the United States. This is compensated for by adjusting the exchange rates in the formula using the consumer price index of the respective countries.