Exchange Rate

A nominal Effective Exchange Rate (NEER) is a measure of the value of a currency against a weighted average of several foreign currencies. 

• The nominal exchange rate is the amount of domestic currency needed to purchase foreign currency. 
• If a domestic currency increases against a basket of other currencies inside a floating exchange rate regime, NEER is said to appreciate. 
• If the domestic currency falls against the basket, the NEER depreciates..
• An increase in NEER indicates an appreciation of the local currency against the weighted basket of currencies of its trading partners. 

The real effective Exchange Rate (REER) is the real effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs. 

In simple words, a nation's nominal effective exchange rate (NEER), adjusted for inflation in the home country, equals its real effective exchange rate (REER).

An increase in REER implies that exports become more expensive and imports become cheaper; therefore, an increase indicates a loss in trade competitiveness.

If inflation is in an increasing trend in domestic nation relative to inflation in other countries, there is likely to cause an increasing divergence between NEER and REER.

Source: VisionIAS