Real Exchange Rate Calculation

Real Exchange Rate (RER) Calculator

What is the Real Exchange Rate?

The Real Exchange Rate (RER) is a fundamental economic metric that measures the relative purchasing power of two currencies. Unlike the nominal exchange rate, which tells you how much foreign currency you can buy with a unit of domestic currency, the RER tells you how many units of a foreign "goods basket" you can buy with one unit of a domestic "goods basket."

Economists use the RER to assess the international competitiveness of a country. A high RER indicates that domestic goods are expensive relative to foreign goods, potentially hurting exports. A lower RER suggests that domestic goods are cheaper and more competitive on the global stage.

Formula: RER = e × (P / P*)

• e: The Nominal Exchange Rate (Foreign currency per unit of Domestic currency).
• P: The Domestic Price Level (usually measured by the Consumer Price Index).
• P*: The Foreign Price Level (usually measured by the Foreign CPI).

Real-World Example

Imagine the following scenario between the United States (Foreign) and the Eurozone (Domestic):

• Nominal Rate: 1.10 USD per 1 EUR.
• Eurozone CPI: 100
• US CPI: 100

In this case, the RER is 1.10 × (100 / 100) = 1.10. If the Eurozone inflation rises and the Eurozone CPI becomes 110 while the US CPI stays at 100, the RER becomes 1.10 × (110 / 100) = 1.21. This means the Euro has appreciated in "real" terms, making European goods more expensive for Americans even if the nominal exchange rate remained the same.

Why the Real Exchange Rate Matters

Understanding RER is vital for multinational businesses, investors, and policymakers. It dictates the balance of trade; if the RER rises (real appreciation), the country's exports become more expensive for foreigners, and imports become cheaper for locals. Conversely, a real depreciation (falling RER) can stimulate exports and help reduce a trade deficit.