Real exchange rate
The nominal exchange rate adjusted for relative price levels, so it measures what one country's goods buy of the other's. It, not the quoted rate, decides competitiveness abroad.
Where you will meet it
Real exchange rate appears in 4 learning outcomes on the CFA syllabus. A few of them:
- Tell real exchange rates apart from nominal ones and find the percentage move in a currency
“The real exchange rate adjusts it for relative price levels, measuring purchasing power: real rate (price/base) = nominal rate x (base country price level / price country price level).”
- Explain the ways of estimating what an exchange rate is fairly worth over the long run
“Reduced-form econometric models regress the real exchange rate on fundamentals such as productivity and terms of trade.”
- Set out the signals that a currency crisis may be coming
“Warning signs include a real exchange rate well above its historical average, falling reserves, deteriorating terms of trade, rapid domestic credit growth often after financial liberalisation, large capital inflows that start to reverse, inflation high relative to trading partners, broad money growing fast relative to reserves, weakening output and banking stress.”
- Explain the effect of natural resources on growth and judge the claim that scarce resources hold growth back
“Under Dutch disease, resource exports push up the real exchange rate, making manufacturing and other traded sectors uncompetitive, and those sectors often generate productivity gains; resource rents can also weaken institutions.”
See also
Practise it
Practise real exchange rate until it is automatic: questions that explain every wrong option.
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