Real Effective Exchange Rate (REER)

What is REER?

The Real Effective Exchange Rate (REER) is an index that measures a currency’s value against a basket of foreign currencies after adjusting for relative price levels (inflation). Each partner currency is weighted according to its share in the home country’s trade. REER is used to assess trade competitiveness: a rising REER generally means exports become more expensive and imports cheaper, reducing competitiveness; a falling REER tends to improve competitiveness.

How REER is calculated

REER is typically computed as a weighted geometric average of bilateral real exchange rates:

1. Calculate each bilateral real exchange rate (adjusting the nominal rate for relative price levels between the home country and each partner).
2. Assign trade weights to each partner currency (weights sum to 1), usually based on trade shares.
3. Compute the geometric weighted average of the bilateral real rates.
4. Multiply the result by 100 to form an index.

Formula (compact):
REER = (∏_{i=1}^n e_i^{w_i}) × 100
where e_i is the real bilateral exchange rate with partner i and w_i is its trade weight.

In practice, institutions like the Bank for International Settlements and the IMF publish REER/NEER indices and the underlying data.

Example

If the U.S. trades only with the eurozone (70% weight), the U.K. (20%), and Australia (10%), movements in the euro–dollar rate will affect the U.S. REER far more than comparable moves in the Australian dollar. If the euro strengthens versus the dollar, the U.S. REER rises, implying reduced U.S. export competitiveness with larger effect due to the higher euro weight.

REER vs. related concepts

• Spot exchange rate: the current market price to exchange one currency for another (transaction-level). REER is an index reflecting value relative to many partners and adjusted for prices.
• Nominal Effective Exchange Rate (NEER): a weighted average of nominal exchange rates (no price adjustment). REER = NEER adjusted for relative inflation (price levels).
• Real exchange rate (bilateral): the inflation-adjusted exchange rate between two countries. REER aggregates many bilateral real rates into a trade-weighted index.

Interpretation and what it indicates

• Higher REER: domestic goods and services are relatively more expensive abroad → weaker trade competitiveness.
• Lower REER: domestic goods and services are relatively cheaper abroad → stronger trade competitiveness.
  Interpretation should consider other factors (see limitations).

Limitations

• Non-trade factors: capital flows, interest-rate differentials, and monetary policy can move exchange rates without reflecting trade competitiveness.
• Price structure and tariffs: REER adjusts for general price levels but may not capture sectoral price differences, tariffs, or non-tariff barriers.
• Weighting and timing: trade patterns change; weights and price data must be updated to remain accurate.
• Aggregation masks bilateral differences: an unchanged REER can hide large offsetting moves across partners.
• Measurement issues: data quality for prices, trade shares, and exchange rates affects accuracy.

Key takeaways

• REER is a trade‑weighted, inflation‑adjusted index of a currency’s value versus a basket of partner currencies.
• It helps assess export/import competitiveness: rising REER implies loss of competitiveness, falling REER implies gain.
• REER complements, but does not replace, analysis of bilateral exchange rates, monetary policy, and trade policies.
• Official REER series are published by international organizations (e.g., BIS, IMF) and are useful starting points for macroeconomic and trade analysis.