Real Exchange Rate Calculation Example

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Real Exchange Rate (RER) Calculator

Units of Foreign Currency per 1 unit of Domestic Currency (e.g., 1.10 USD/EUR)

Price of a basket of goods in the home country (in local currency)

Price of the same basket in the foreign country (in foreign currency)

Calculation Result:

RER = 0

function calculateRER() { var e = parseFloat(document.getElementById('nominalRate').value); var P = parseFloat(document.getElementById('domesticPrice').value); var Pstar = parseFloat(document.getElementById('foreignPrice').value); var resultDiv = document.getElementById('rerResult'); var rerValueSpan = document.getElementById('rerValue'); var interpretationDiv = document.getElementById('rerInterpretation'); if (isNaN(e) || isNaN(P) || isNaN(Pstar) || e <= 0 || P <= 0 || Pstar 1) { interpretation = "Interpretation: The Real Exchange Rate is greater than 1. This suggests that the domestic currency is overvalued relative to the foreign currency in terms of purchasing power. Domestic goods are more expensive than foreign goods, which may hurt exports but make imports cheaper."; } else if (rer < 1) { interpretation = "Interpretation: The Real Exchange Rate is less than 1. This suggests that the domestic currency is undervalued relative to the foreign currency. Domestic goods are cheaper compared to foreign goods, which generally boosts international competitiveness and exports."; } else { interpretation = "Interpretation: The Real Exchange Rate is 1. This indicates Purchasing Power Parity (PPP). The cost of goods is effectively the same in both countries when converted at the nominal exchange rate."; } interpretationDiv.innerHTML = interpretation; }

Understanding the Real Exchange Rate (RER)

The Real Exchange Rate (RER) is a fundamental economic metric used to measure the relative purchasing power between two currencies. Unlike the nominal exchange rate, which simply tells you how much of one currency you get for another, the RER accounts for price level differences (inflation and cost of living) between two nations.

The Real Exchange Rate Formula

To calculate the real exchange rate, you need three specific variables. The formula is expressed as:

RER = (e × P) / P*
  • e: The Nominal Exchange Rate (foreign currency per one unit of domestic currency).
  • P: The Domestic Price Level (price of a basket of goods in the home country).
  • P*: The Foreign Price Level (price of the same basket of goods in the foreign country).

Real Exchange Rate Calculation Example

Let's look at a realistic scenario involving the United States and the Eurozone to see how this works in practice.

Scenario:
  • Domestic (USA): Price of a specific tech gadget = $500 (P)
  • Foreign (Eurozone): Price of the same gadget = €450 (P*)
  • Nominal Rate (e): 1 USD = 0.90 EUR

Step 1: Multiply the nominal rate by the domestic price.
0.90 × 500 = 450 EUR

Step 2: Divide the result by the foreign price.
450 / 450 = 1.00

Result: The RER is 1.00. This means the gadget has the same real cost in both locations once currency conversion is applied.

Why the Real Exchange Rate Matters

Monitoring the RER is critical for policymakers, international traders, and investors for several reasons:

  1. Trade Competitiveness: If a country's RER increases (the currency appreciates in real terms), its exports become more expensive for foreigners, and imports become cheaper for locals. This often leads to a trade deficit.
  2. Standard of Living: A high RER indicates that the domestic currency has high purchasing power abroad, allowing citizens to buy more foreign goods and services for less.
  3. Inflation Indicators: Large discrepancies between the nominal and real exchange rates often signal high domestic inflation relative to trading partners.

Nominal vs. Real Exchange Rate

Feature Nominal Exchange Rate Real Exchange Rate
Definition Relative price of currencies. Relative price of goods/services.
Includes Inflation? No. Yes.
Usage Daily currency trading. Economic health & trade analysis.

Summary of Interpretation

When using the calculator above, keep these rules of thumb in mind:

  • RER > 1: Domestic goods are relatively more expensive. The currency is "strong" but potentially uncompetitive in global trade.
  • RER < 1: Domestic goods are relatively cheaper. The country is more competitive in the export market.
  • RER = 1: No arbitrage opportunity exists; the cost of goods is equalized across borders.

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