What Is the Real Effective Exchange Rate (REER)
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StoneX market expertsThe Real Effective Exchange Rate (REER), despite its limitations, is a powerful quantitative tool for determining a country’s currency relative to its trading partners. In essence it is an economic indicator that can help determine if a currency is undervalued, overvalued or in a state of equilibrium.
When a currency is in a state of equilibrium (fairly valued), despite the daily currency fluctuations demand and supply for that currency are equally balanced, and prices remain stable. When a currency has a rising REER, it appreciates in real terms and exports may become less competitive. The corollary is also true, if a REER is in decline, it signals improved competitiveness for a nation's exports. Although volatile in the short term, REER is an important measure for policymakers such as the International Monetary Fund and Bank of International Settlements.
Managing the vagaries of a currency requires good risk management and StoneX’s corporate Foreign Exchange (FX) desk offers a wide range of OTC FX instruments, which assists our clients to navigate volatile markets.
The formula for Real Effective Exchange Rate
There are several ways to calculate Real Effective Exchange Rates.
The basic method entails taking the weighted average of a country’s real exchange rate against its major trading partners, adjusted for relative inflation, which measures the overall external price competitiveness.
- Ei = Nominal exchange rate with country i (units of foreign currency per unit of domestic currency)
- Pi = Price index (e.g., CPI) in trading partner i
- Pd = Domestic price index
- wi = Trade weight for country i (based on trade volume or share)
- n = number of trading partners
The formula for Real Exchange Rate
The Real Exchange Rate (RER) formula shows the nominal exchange rate adjusted for the ratio of foreign to domestic price levels.
- E= nominal exchange rate
- P∗ = foreign price level
- P = domestic price level
What does the Real Effective Exchange Rate tell you?
When a country’s REER is high it likely means that the currency has appreciated in real terms, which makes its exports to other trading partners less competitive (expensive) and the imports more attractive (inexpensive). A high REER is also likely to lead to a downward pressure on inflation, as it makes imports cheaper, putting downward pressure on tradable goods inflation. This can hurt external competitiveness, potentially worsening the trade balance. While a lower REER has the opposite effect, it leads to rising inflation, boosts exports, and improves the current account balance.
Example of Real Exchange Rate
The Real Effective Exchange Rate also tells you how much of one country’s goods you can buy with the goods of the countries it trades with at the current nominal exchange rate; it provides a good barometer of an economy’s competitiveness relative to its trading partners.
This concept is best illustrated by using the price of a McDonald’s Big Mac burger. If the nominal USD/EUR exchange rate is 0.90, and a Big Mac costs $3.25 in the U.S. and €2.93 in Austria, the real exchange rate is 1. This means that both the Euro and Dollar have purchasing power parity. In theory under these conditions, one can sell a Big Mac in the U.S for Dollars and buy Euros with those Dollars to purchase a replacement Big Mac in Austria priced in Euros.
When the USD/EUR exchange rate is 0.90, and the Big Mac costs $3.25 in the U.S and €3.25 in Austria. The real effective exchange rate will be 0.9. Effectively, the price is the same in local terms, but the currency effect means US goods are more expensive in euro terms
If we assume that the nominal USD/EUR exchange rate is 0.85, and the relative consumer price index for the Eurozone is 90 compared to the US which is 130 the real exchange rate will be 1.2277. This means that goods in the US are more expensive than in the Eurozone.
Real Effective Exchange Rate vs Real Exchange Rate
While both the Real Exchange Rate (RER) and the Real Effective Exchange Rate (REER) are somewhat closely related, they do serve different purposes. The RER measures the relative price of domestic goods to foreign goods adjusted for inflation between two countries. The REER is a trade-weighted average of multiple RERs measured against a group of major trading partners also adjusted for inflation.
Feature | Real Exchange Rate (RER) | Real Effective Exchange Rate (REER) |
|---|---|---|
Scope | Bilateral (one country) | Multilateral (basket of trading partners) |
Inflation Adjustment | Yes | Yes |
Trade Weights | No | Yes |
Purpose | Country-to-country comparison | Overall global competitiveness |
Example Use | Compare with the U.S. only | Compare against U.S., EU, China, etc. together |
Expression | Ratio or index | Index (e.g., base year = 100) |
Real Effective Exchange Rate vs. Spot Exchange Rate
The Spot Exchange Rate is the current market price to exchange one currency for another immediately (typically settled in two business days). The spot exchange rate is what most people see quoted in foreign exchange markets for immediate trade. While a REER measures a currency’s value relative to a basket of currencies, adjusted for inflation differentials and weighted by trade. StoneX provides specialized foreign exchange services to investors, self-directed traders and corporates who engage in foreign trade and enables them to send money all over the world and hedge against FX volatility.
Limitations of the Real Effective Exchange Rate
The real effective exchange rate does not consider non-price factors like tariffs, quality, logistics, competitiveness, etc. s. If prices are higher in one country compared with another, trade may decrease in the country with higher prices, which will impact its REER.
Limitation | Impact on REER Interpretation |
|---|---|
Use of general price indices | May not reflect tradable goods prices accurately |
Static trade weights | Can misrepresent current trade patterns |
Limited partner scope | Misses emerging or niche trade relationships |
Ignores non-price factors | Incomplete measure of global competitiveness |
Assumes fast exchange rate pass-through | May distort short-term competitiveness |
Data quality and revisions | Undermines accuracy and reliability |
Real Exchange Rate vs Real Effective Exchange Rate
The Real Exchange Rate (RER) and the Real Effective Exchange Rate are both used to determine a country’s currency value when adjusted for inflation. However, they differ when it relates to scope, calculation and application.
Feature | Real Exchange Rate (RER) | Real Effective Exchange Rate (REER) |
|---|---|---|
Scope | Between two countries (bilateral) | With a basket of trading partners (multilateral) |
Trade Weights | ❌ Not included | ✅ Included |
Inflation Adjusted | ✅ Yes | ✅ Yes |
Purpose | Analyze price competitiveness with one country | Analyze overall trade competitiveness |
Expression | Ratio or index | Indexed (base year = 100) |
Policy Use | Limited (specific trade partners) | Widely used for macroeconomic policy |
For more information about macroeconomic policy and how it may impact REER, browse our Market Intelligence subscriptions for data-driven insights and trend analysis.
What is the difference between NEER and REER?
If the nominal exchange rate tells you how much of one country’s currency you can buy with another country’s currency, the REER tells you how much of one country’s goods you could buy with the goods of the countries it trades with, at the current nominal exchange rate. The REER is a gauge of how competitive an economy is relative to its trading partners.
A nominal effective exchange rate is a weighted average of a country’s nominal exchange rate against a basket of its major trading partners’ currencies without adjusting for inflation. It reflects the overall external value of a country’s currency in nominal terms.
What does a high real effective exchange rate mean?
A high REER generally indicates that a country’s currency is overvalued in real terms, which implies that the goods and services of its exports become relatively more expensive, and imports become cheaper when compared to those of its trading partners after adjusting for inflation which indicates a loss in trade competitiveness.
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This material is for informational purposes only and should not be considered as an investment recommendation or a personal recommendation.
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