TURNER, P., 2004. Calculating the real exchange rate. Economic Review, 21(3), pp. 6-9
Economists and financial commentators often refer to the exchange rate when they
discuss the economic situation. However, for each currency there are as many exchange
rates as there are other currencies and it is difficult to judge which if any should be
considered the most important. In this article we will show how it is possible to take data
for individual exchange rates and construct an index which is economically meaningful.
First we show how to average exchange rate data to construct a measure known as the
effective exchange rate. This allows us to judge whether on average the pound has
appreciated or depreciated relative to other world currencies. However, the effective
exchange rate does not make allowances for differences in the price of goods between
different countries. Therefore in the next section we show how we can make such an
adjustment to obtain a measure known as the real effective exchange rate. In the final
section this allows us to discuss the impact of the exchange rate on the level of
international competitiveness and hence on the overall economy. All data in this article
are taken from the IMF’s International Financial Statistics database.