![ABS-5302](https://upload.wikimedia.org/wikipedia/commons/f/fe/ABS-5302.0-BalancePaymentsInternationalInvestmentPositionAustralia-ExchangeRates_Quarter-TradeWeightedIndex-EndPeriod-A3533868J.svg)
The trade-weighted effective exchange rate index, a common form of the
effective exchange rate index The effective exchange rate index describes the strength of a currency relative to a basket of other currencies. Although typically the basket is trade weighted, there are others besides the trade-weighted effective exchange rate index.
Ho (2012) p ...
, is a multilateral exchange rate index. It is compiled as a weighted average of exchange rates of ''home'' versus ''foreign'' currencies, with the weight for each ''foreign'' country equal to its share in trade. Depending on the purpose for which it is used, it can be export-weighted, import-weighted, or total-external trade weighted.
The trade-weighted effective exchange rate index is an economic indicator for comparing the
exchange rate
In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of ...
of a country against those of their major trading partners. By design, movements in the currencies of those trading partners with a greater share in an economy's exports and imports will have a greater effect on the effective exchange rate. In a multilateral, highly globalized, world, the effective exchange rate index is much more useful than a bilateral exchange rate, such as that between the
Australian dollar
The Australian dollar (sign: $; code: AUD) is the currency of Australia, including its external territories: Christmas Island, Cocos (Keeling) Islands, and Norfolk Island. It is officially used as currency by three independent Pacific Island s ...
and the
United States dollar
The United States dollar ( symbol: $; code: USD; also abbreviated US$ or U.S. Dollar, to distinguish it from other dollar-denominated currencies; referred to as the dollar, U.S. dollar, American dollar, or colloquially buck) is the officia ...
, for assessing changes in the competitiveness due to exchange rate movements.
Generally, the weighting method is geometric weighting rather than arithmetic weighting. Refer to
weighted geometric mean
In statistics, the weighted geometric mean is a generalization of the geometric mean using the weighted arithmetic mean.
Given a sample x=(x_1,x_2\dots,x_n) and weights w=(w_1, w_2,\dots,w_n), it is calculated as:
: \bar = \left(\prod_^n x_i^\ri ...
.
The use of trade weights in a globalized economy is potentially misleading, because the amount of value added content in exports destined for a country may deviate significantly from the gross value of exports shipped to that country. See the entry under
effective exchange rate index The effective exchange rate index describes the strength of a currency relative to a basket of other currencies. Although typically the basket is trade weighted, there are others besides the trade-weighted effective exchange rate index.
Ho (2012) p ...
for an alternative approach to compiling an effective exchange rate index.
The interpretation of the effective exchange rate is that if the index rises, other things being equal, the purchasing power of that currency also rises (the currency strengthened against those of the country's or area's trading partners). That will reduce the cost of imports but will undermine the competitiveness of exports. Other things refer, in particular, to the relative inflation rates of the economy as compared to the inflation rates of its trading partners. To account for all effects of relative inflation rates, the real effective exchange rate index is compiled as the product of the effective exchange rate index and the relative price index between the home economy and the trading partners.
External links
*Data from
Bank for International Settlements
The Bank for International Settlements (BIS) is an international financial institution owned by central banks that "fosters international monetary and financial cooperation and serves as a bank for central banks".
The BIS carries out its work thr ...
effective exchange rate indices*Monthly data from U.S. Federal Reserve
Monthly Rates*Effectiv
exchange ratesof the
euro
The euro ( symbol: €; code: EUR) is the official currency of 19 out of the member states of the European Union (EU). This group of states is known as the eurozone or, officially, the euro area, and includes about 340 million citizens . ...
from the
European Central Bank
The European Central Bank (ECB) is the prime component of the monetary Eurosystem and the European System of Central Banks (ESCB) as well as one of seven institutions of the European Union. It is one of the world's Big Four (banking)#Intern ...
datamethodology
Economic indicators
Index numbers
Foreign exchange market
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