How to Calculate the Real Exchange Rate
The real exchange rate equals the nominal exchange rate times the domestic price level divided by the foreign price level.
The Real Exchange Rate formula
Calculator
Enter the nominal rate and both price levels to get the real exchange rate and what a nominal move does to it.
Foreign currency per 1 unit of domestic currency, the convention this formula assumes.
Home price index, on the same base year as the foreign one.
Foreign price index from the same base year, or the ratio is meaningless.
Optional second scenario, used only for the change figures below.
One home basket trades for 0.88 foreign baskets at a nominal rate of 0.8.
- Price level ratio
- 1.1
- Real rate after the move
- 0.99
- Change in the real rate
- 12.5%
- Reading
- Home goods relatively cheap
Home prices sit at 1.1 times foreign prices on the shared base year.
Holding both price levels still, a nominal rate of 0.9 gives a real rate of 0.99.
Home goods became 12.5% more expensive relative to foreign goods.
Below 1 means one home basket buys less than one foreign basket, so exports look competitive.
How to calculate Real Exchange Rate, step by step
- 1Fix the quoting convention. Write the nominal rate as units of foreign currency per one unit of domestic currency, which is the convention this version of the formula assumes.
- 2Collect both price levels. Take the domestic and foreign price indexes from the same base year, otherwise the ratio between them means nothing.
- 3Multiply the nominal rate by the price ratio. Real rate = nominal rate × (domestic price level ÷ foreign price level).
- 4Read the result. The answer is how many foreign baskets trade for one domestic basket, and a rise says home goods just got relatively more expensive.
Worked example: Real Exchange Rate
Suppose the nominal rate is 0.80 euros per dollar, the domestic price index is 110, and the foreign price index is 100 on the same base year. The real exchange rate = 0.80 × (110 ÷ 100) = 0.88, so one home basket trades for 0.88 foreign baskets and home goods are relatively cheap. If the dollar then appreciates to 0.90 euros with both price levels unchanged, the real rate = 0.90 × 1.10 = 0.99, a rise of (0.99 − 0.88) ÷ 0.88 × 100 = 12.5%, meaning home goods became 12.5% more expensive relative to foreign goods.
Real Exchange Rate questions
What is the difference between the nominal and the real exchange rate?
The nominal rate is the market price of one currency in terms of another, while the real rate adjusts that price for both countries' price levels so you can compare what goods actually cost.
Which price level goes on top?
With the nominal rate quoted as foreign currency per home unit, the domestic price level goes in the numerator. If your textbook quotes the rate as home currency per foreign unit, the ratio flips to foreign over domestic.
What does a rising real exchange rate mean for exports?
It means home goods cost more relative to foreign goods, so exports become less competitive and imports look cheaper to domestic buyers.
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