How to Calculate Real Exchange Rate Macroeconomics

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Real Exchange Rate Calculator

Foreign currency units per 1 unit of domestic currency (Indirect Quote).
Consumer Price Index (CPI) or cost of market basket at home.
Consumer Price Index (CPI) or cost of market basket abroad.

Result:

0.00

How to Calculate Real Exchange Rate in Macroeconomics

The Real Exchange Rate (RER) is a crucial concept in international macroeconomics that measures the relative price of goods and services between two countries. Unlike the nominal exchange rate, which simply tells you how much foreign currency you can buy with your domestic currency, the real exchange rate adjusts for price differences (inflation) between the two economies.

Economists use the real exchange rate to determine the true purchasing power of a currency and to assess a country's trade competitiveness. A rising real exchange rate implies that domestic goods are becoming relatively more expensive compared to foreign goods, which can hurt exports.

The Formula

To calculate the real exchange rate, macroeconomists typically use the following formula:

Real Exchange Rate (ε) = (e × P) / P*

Where:

  • e (Nominal Exchange Rate): The number of units of foreign currency per one unit of domestic currency.
  • P (Domestic Price Level): The price level in the home country (often measured by CPI).
  • P* (Foreign Price Level): The price level in the foreign country (often measured by CPI).

Example Calculation

Imagine you are comparing the US (Domestic) and the Eurozone (Foreign).

  • Nominal Exchange Rate (e): 0.85 Euros per 1 USD.
  • Domestic Price Level (US CPI): 120.
  • Foreign Price Level (Eurozone CPI): 110.

Using the calculator above:

RER = (0.85 × 120) / 110 = 102 / 110 ≈ 0.927

This result indicates the rate at which US goods trade for European goods. Since the result is close to 1, purchasing power is relatively similar, adjusted for exchange rates.

Why is this important?

Competitiveness: If the Real Exchange Rate is high (greater than 1 or rising), domestic goods are expensive abroad, potentially leading to a trade deficit. If it is low, domestic goods are cheap, boosting exports.

Purchasing Power Parity (PPP): In the long run, many economists theorize that the real exchange rate should tend toward 1, meaning a unit of currency should buy the same basket of goods anywhere in the world.

function calculateRealExchangeRate() { var nominalRate = parseFloat(document.getElementById('nominalExchangeRate').value); var domesticPrice = parseFloat(document.getElementById('domesticPriceLevel').value); var foreignPrice = parseFloat(document.getElementById('foreignPriceLevel').value); var resultBox = document.getElementById('rerResult'); var outputValue = document.getElementById('rerOutput'); var interpretationText = document.getElementById('rerInterpretation'); // Validation if (isNaN(nominalRate) || isNaN(domesticPrice) || isNaN(foreignPrice)) { alert("Please enter valid numerical values for all fields."); return; } if (foreignPrice === 0) { alert("Foreign Price Level cannot be zero."); return; } // Calculation: RER = (Nominal Rate * Domestic Price) / Foreign Price var realExchangeRate = (nominalRate * domesticPrice) / foreignPrice; // Display Result resultBox.style.display = "block"; outputValue.innerHTML = realExchangeRate.toFixed(4); // Interpretation Logic var text = ""; if (realExchangeRate > 1.05) { text = "The Real Exchange Rate is greater than 1. This suggests domestic goods are relatively more expensive than foreign goods (Real Appreciation). This may negatively impact exports."; } else if (realExchangeRate < 0.95) { text = "The Real Exchange Rate is less than 1. This suggests domestic goods are relatively cheaper than foreign goods (Real Depreciation). This may make exports more competitive."; } else { text = "The Real Exchange Rate is close to 1. This suggests that Purchasing Power Parity (PPP) holds relatively well between these two economies."; } interpretationText.innerHTML = "Interpretation: " + text + "Mathematically, 1 unit of domestic goods can be exchanged for " + realExchangeRate.toFixed(2) + " units of foreign goods."; }

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