How to Calculate the Real Exchange Rate: A Step-by-Step Guide

Learn how to accurately calculate the real exchange rate with our easy-to-follow guide and examples.

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Calculating the real exchange rate (RER) involves comparing the relative price of goods between two countries. The formula is: RER = (Nominal Exchange Rate × Domestic Price) / Foreign Price. For example, if the nominal exchange rate is 1.5, the domestic price level is 100, and the foreign price level is 120, you calculate RER as (1.5 × 100) / 120 = 1.25. This tells you how much foreign goods cost compared to domestic goods after adjusting for price levels.

FAQs & Answers

  1. What is the difference between nominal and real exchange rates? The nominal exchange rate is the rate at which you can exchange one currency for another without adjusting for inflation, while the real exchange rate adjusts for price level differences between countries.
  2. Why is the real exchange rate important? The real exchange rate is crucial for assessing a country's competitiveness, as it reflects the true cost of goods and services compared to foreign countries.
  3. How does inflation affect the real exchange rate? Inflation can affect the real exchange rate by altering the domestic price level, which directly impacts the RER calculation.

Watch More

For further insights into currency valuation and economic indicators, check out our videos on nominal exchange rates and purchasing power parity.

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