Real Exchange Rate Calculator
Calculation Result
Real Exchange Rate (RER):
Understanding the Real Exchange Rate (RER)
The Real Exchange Rate (RER) is a fundamental economic metric used to measure the purchasing power of one currency against another relative to the prices of goods and services. Unlike the nominal exchange rate, which simply tells you how much of one currency you get for another, the RER tells you how many "baskets of goods" in a foreign country you can buy with one "basket of goods" in your home country.
The Real Exchange Rate Formula
To calculate the Real Exchange Rate, we use the following formula:
- e: The Nominal Exchange Rate (Foreign currency units per 1 domestic unit).
- P: The Domestic Price Level (Domestic CPI or cost of a standard basket of goods).
- P*: The Foreign Price Level (Foreign CPI or cost of a standard basket of goods).
Interpreting the Results
The resulting RER provides insight into the competitiveness of a nation's exports and the cost of imports:
- RER = 1: This is known as Purchasing Power Parity (PPP). Goods cost the same in both countries when converted to a single currency.
- RER > 1: The domestic currency is "overvalued" in real terms. Domestic goods are more expensive than foreign goods, which may hurt exports but make imports cheaper.
- RER < 1: The domestic currency is "undervalued" in real terms. Domestic goods are cheaper than foreign goods, which generally boosts exports as they are more competitive abroad.
Example Calculation
Suppose the Euro (EUR) is the domestic currency and the US Dollar (USD) is the foreign currency:
- Nominal Rate (e): 1.10 USD per 1 EUR.
- Domestic Price (P): A basket of goods costs €100 in Europe.
- Foreign Price (P*): The same basket costs $105 in the USA.
Calculation: RER = (1.10 × 100) / 105 = 110 / 105 = 1.0476.
In this scenario, the Real Exchange Rate is greater than 1, suggesting that the Euro is slightly overvalued relative to the Dollar, and European goods are more expensive than American goods in real terms.