Effective exchange rate

Effective Exchange Rate is an index that describes the relative strength of a currency relative to a basket of other currencies. Suppose a country has $N$ trading partners and denote $Trade_i$ and $E_i$ as the trade and exchange rate with country $i$ respectively. Then the effective exchange rate is calculated as:

$E_{effective} = E_1 \frac{Trade_1}{Trade} + ... + E_N \frac{Trade_N}{Trade}$

Although typically that basket is trade-weighted, the trade-weighted effective exchange rate index is not the only way to derive a meaningful effective exchange rate index. Ho (2012) proposed a new approach to compiling effective exchange rate indices. It defines the effective exchange rate as a ratio if the "normalized Exchange Value of Currency i against the US dollar" to the normalized exchange value of the "benchmark currency basket" against the US dollar. The US dollar is here used as numeraire for convenience, and since it cancels out, in principle any other currency can be used instead without affecting the results. The benchmark currency basket is a GDP-weighted basket of the major fully convertible currencies of the world.

单词	Effective exchange rate
释义	Effective exchange rate 英语百科 Effective exchange rate Effective Exchange Rate is an index that describes the relative strength of a currency relative to a basket of other currencies. Suppose a country has $N$ trading partners and denote $Trade_i$ and $E_i$ as the trade and exchange rate with country $i$ respectively. Then the effective exchange rate is calculated as: $E_{effective} = E_1 \frac{Trade_1}{Trade} + ... + E_N \frac{Trade_N}{Trade}$ Although typically that basket is trade-weighted, the trade-weighted effective exchange rate index is not the only way to derive a meaningful effective exchange rate index. Ho (2012) proposed a new approach to compiling effective exchange rate indices. It defines the effective exchange rate as a ratio if the "normalized Exchange Value of Currency i against the US dollar" to the normalized exchange value of the "benchmark currency basket" against the US dollar. The US dollar is here used as numeraire for convenience, and since it cancels out, in principle any other currency can be used instead without affecting the results. The benchmark currency basket is a GDP-weighted basket of the major fully convertible currencies of the world.
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