Real Exchange Rate

A bilateral exchange rate that has been adjusted for price changes in the two nations.

Consider an example with the U.S. dollar and the euro between April 2000 and April 2002. During this period the euro declined relative to the dollar. In April 2000, the euro-dollar exchange rate was 1.058. By April 2002, the euro's value had fallen, and the exchange rate had climbed to 1.123 euro/dollar. Based on the values of these nominal exchange rates, the rate of appreciation of the dollar relative to the euro between April 2000 and April 2002 was equal to 6.71%. But the consumer price inflation from April 2000 to April 2002 in Europe was 5.4% and in the U.S. it was 5%. If we take the relative inflation difference we see that the real rate of dollar appreciation during the period of April 2000 to April 2002 was [6.71 % - (5.4% - 5%)] = 6.23%.
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