Question

Compare and contrast the effective rate of exchange with the real exchange rate

Answer 1

Effective rate of exchange: Nominal and real effective rate of exchange.

Nominal effective exchange rate is calculated as a weighted average of bilateral nominal exchange rates of national currencies against foreign currencies. Real effective exchange rate is calculated as the weighted average of a country's currency against a basket of other major currencies adjusted to the effects of inflation.

Real exchange rate is defined as the ratio of the price abroad and the domestic price level where the foreign price is converted into domestic currency units via current nominal exchange rate.