Exchange rate

Real Exchange Rate

Exchange Rate

The real exchange rate measures the price of foreign goods relative to the price of domestic goods.

Mathematically, the real exchange rate is the ratio of a foreign price level and the domestic price level, multiplied by the nominal exchange rate.


R = (E.P*)/P

R: real exchange rate
E: nominal exchange rate
P*: foreign price level
P: domestic price level


Nominal Exchange Rate

The nominal exchange rate is defined as:

The number of units of the domestic currency that are needed to purchase a unit of a given foreign currency.

For example, if the value of the Euro in terms of the dollar is 1.37, this means that the nominal exchange rate between the Euro and the dollar is 1.37. We need to give 1.37 dollars to buy one Euro.