What is Neer And Reer?

Foreign exchange rates play an important role in the global economy. It makes an impact upon trade, investment and overall financial stability. Two key concepts that economists and policymakers often use to analyse and evaluate exchange rates are the Nominal Effective Exchange Rate (NEER) and the Real Effective Exchange Rate (REER). These measures help us gain a deeper understanding of a country's currency value, its competitiveness in international markets and the overall economic implications.

Nominal Effective Exchange Rate (NEER)

The NEER is a measure of a country's exchange rate in comparison to the currencies of its major trading partners. It is expressed as a weighted average of the exchange rates between the home currency (e.g., the US dollar) and the foreign currencies of the countries with which the home country conducts significant trade.

Here's How it Works:

A country's NEER is calculated by taking the weighted average of all the bilateral exchange rates between its currency and the currencies of its trading partners. The weights are determined based on the importance of trade with each partner.

The NEER is called "nominal" because it reflects the exchange rate in current market terms without any adjustments for inflation or changes in relative price levels.

Basically, NEER tells us how a country's currency is performing against a basket of foreign currencies without considering the impact of domestic inflation or price changes.

Real Effective Exchange Rate (REER)

The REER on the other hand is a measure that adjusts the NEER for differences in price levels (inflation) between the home country and its trading partners. This makes it a more accurate reflection of a country's competitiveness in international markets.

To Calculate the REER:

Start with the NEER as the base.

Adjust it by the ratio of domestic prices to foreign prices. This is done using a price index such as the Consumer Price Index (CPI).

The result is a measure of a country's currency value after accounting for changes in relative price levels. This reflects whether a country's currency has appreciated or depreciated in real terms, affecting its ability to buy foreign goods and services.

Importance of NEER and REER

Trade Competitiveness:

Both NEER and REER are crucial for assessing a country's trade competitiveness. A rise in the REER indicates that a country's currency has appreciated, potentially making its exports more expensive and imports cheaper.

Economic Stability:

These measures help central banks and policymakers understand how exchange rates impact inflation and economic stability. A high REER may lead to inflation concerns.

Investment Decisions:

For investors, NEER and REER can provide insights into potential currency risks and opportunities. Understanding the relative strength or weakness of a currency is crucial for making investment decisions in international markets.

Economic Policy:

Governments and central banks often use these measures to shape their economic policies. For instance, if a country's currency is too strong (high REER), they might intervene in the foreign exchange market to weaken it and boost export competitiveness.

In Conclusion

The Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) are essential tools for understanding a country's exchange rate dynamics. While NEER provides insight into the currency's value relative to trading partners, the REER takes into account inflation making it a more realistic measure of trade competitiveness and economic stability. These indicators are invaluable for businesses, investors and policymakers in navigating the complex world of international finance.