The trade-weighted effective exchange rate index, a common form of the effective exchange rate index, is a multilateral exchange rate index. It is compiled as a weighted average of exchange rates of ''home'' versus ''foreign'' currencies, with the weight for each ''foreign'' country equal to its share in trade. Depending on the purpose for which it is used, it can be export-weighted, import-weighted, or total-external trade weighted.

Overview

The trade-weighted effective exchange rate index is an economic indicator for comparing the

exchange rate In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of ...

of a country against those of their major trading partners. By design, movements in the currencies of those trading partners with a greater share in an economy's exports and imports will have a greater effect on the effective exchange rate. In a multilateral, highly globalized, world, the effective exchange rate index is much more useful than a bilateral exchange rate, such as that between the

Australian dollar The Australian dollar (currency sign, sign: $; ISO 4217, code: AUD; also abbreviated A$ or sometimes AU$ to distinguish it from other dollar, dollar-denominated currencies; and also referred to as the dollar or Aussie dollar) is the official ...

and the

United States dollar The United States dollar (Currency symbol, symbol: Dollar sign, $; ISO 4217, currency code: USD) is the official currency of the United States and International use of the U.S. dollar, several other countries. The Coinage Act of 1792 introdu ...

, for assessing changes in the competitiveness due to exchange rate movements. Generally, the weighting method is geometric weighting rather than arithmetic weighting. Refer to

weighted geometric mean In statistics, the weighted geometric mean is a generalization of the geometric mean using the weighted arithmetic mean. Given a sample x=(x_1,x_2\dots,x_n) and weights w=(w_1, w_2,\dots,w_n), it is calculated as: : \bar = \left(\prod_^n x_i^\r ...

. The use of trade weights in a globalized economy is potentially misleading, because the amount of value added content in exports destined for a country may deviate significantly from the gross value of exports shipped to that country. See the entry under effective exchange rate index for an alternative approach to compiling an effective exchange rate index.

Interpretation

The interpretation of the effective exchange rate is that if the index rises, other things being equal, the purchasing power of that currency also rises (the currency strengthened against those of the country's or area's trading partners). That will reduce the cost of imports but will undermine the competitiveness of exports. Other things refer, in particular, to the relative inflation rates of the economy as compared to the inflation rates of its trading partners. To account for all effects of relative inflation rates, the real effective exchange rate index is compiled as the product of the effective exchange rate index and the relative price index between the home economy and the trading partners.

References

External links

*Monthly data from U.S. Federal Reserve
Monthly Rates
*Data from

Bank for International Settlements The Bank for International Settlements (BIS) is an international financial institution which is owned by member central banks. Its primary goal is to foster international monetary and financial cooperation while serving as a bank for central bank ...

Effective exchange rate indices
*Effectiv
exchange rates
of the

euro The euro (currency symbol, symbol: euro sign, €; ISO 4217, currency code: EUR) is the official currency of 20 of the Member state of the European Union, member states of the European Union. This group of states is officially known as the ...

from the

European Central Bank The European Central Bank (ECB) is the central component of the Eurosystem and the European System of Central Banks (ESCB) as well as one of seven institutions of the European Union. It is one of the world's Big Four (banking)#International ...

datamethodology
Index numbers Economic indicators Foreign exchange market {{econ-stub