Nominal Effective Exchange Rate (NEER)

A type form of measuring a currency’s nominal exchange rate relative to a basket of other currencies

What is the Nominal Effective Exchange Rate (NEER)?

The nominal effective exchange rate (NEER) is a form of measuring a currency’s nominal exchange rate relative to a basket of other currencies using an unadjusted weighted-average calculation. NEER is also sometimes referred to as the “trade-weighted currency index.”

 

Nominal Effective Exchange Rate
Fig.1: Nominal Effective Exchange Rate of the Euro (1993-2020)

 

NEER may be adjusted to account for the inflation effects of a country relative to the inflation of other countries. When the adjustment is made, the resulting metric is called the real effective exchange rate (REER).

 

Nominal Exchange Rate vs. Real Exchange Rate

A nominal exchange rate is essentially the relative prices between two currencies. For example, if an exchange rate is listed as 1 euro = 1.10 USD, then one euro can be exchanged on the currency exchange market for 1.1 U.S dollars.

It is in contrast with the real exchange rate, which measures the relative price of goods between two countries. The real exchange rate represents the rate at which European countries can exchange their goods for goods in the U.S.

It is usually expressed as Px/Pm, where Px is the price of the export good, and Pm is the price of the input good.

 

Nominal Effective Exchange Rate Explained

Within economics, the nominal effective exchange rate (NEER) is used to measure the international competitiveness and strength of a country’s currency within the foreign exchange (forex) market. NEER is not expressed as a measure in terms of currency; instead, it represents a broad value, typically in an index.

A NEER coefficient that is above 1.0 shows that the domestic currency is worth relatively more than imported currencies. If a NEER coefficient is below 1.0, it shows that the domestic currency is worth relatively less than imported currencies.

If a country’s currency increases relative to a basket of other currencies with floating exchange rates, then the NEER will increase. It signals that more foreign currency can be obtained, on average, for each unit of the domestic currency.

Whereas if a country’s currency decreases relative to a basket of other currencies, the NEER will decrease. It indicates that less foreign currency can be obtained, on average, for each unit of the domestic currency.

 

Calculation of the Nominal Effective Exchange Rate

In order to determine the nominal effective exchange rate of a currency, the basket of foreign currencies that it is being measured against must be determined. The basket is chosen depending on the domestic country’s largest and most important trading partners, as well as general major currencies.

The world’s major currencies are as follows:

  • U.S. dollar (USD)
  • British pound (GBP)
  • Japanese yen (JPY)
  • Euro (EUR)
  • Swiss franc (CHF)
  • Chinese renminbi (CNH)
  • Canadian dollar (CAD)
  • Australian dollar (AUD)
  • New Zealand dollar (NZD)
  • South African rand (ZAR)

 

The basket of foreign currencies is weighted in accordance with the trading value relative to the domestic currency. The value can be measured in export or import value, which includes the total value of exports and imports in combination. It can also be measured in other ways as well. The weights usually are related to the assets and liabilities of separate countries.

 

Practicality of the Nominal Effective Exchange Rate

The NEER is an abstract, relative value that does not measure the strength of a currency in real terms. NEER can only measure whether a currency is strong or weak or is strengthening or weakening relative to other foreign currencies. It essentially indicates which currencies are in higher demand relative to other currencies, whether this is due to perceived value or increased demand for a country’s goods or investments.

Economists utilize NEER to inform international trade decisions. It also used by forex traders who trade foreign exchange currencies for speculative, hedging, or arbitrage reasons.

The International Monetary Fund (IMF) constructs and publishes the nominal and real effective exchange rates for most large, developed countries, aside from data on newly industrialized and developing countries.

Central banks publish the broad effective exchange rates for their respective countries. By observing the data, economists can gain insights on trends and developments in the economy and within the forex market.

 

Example

The Federal Reserve Economic Data (FRED) publishes the Broad Effective Exchange Rate for the United States on their website. Here, we can observe trends in the U.S. dollar’s relative performance during economic expansions and recessions.

 

Broad Effective Exchange Rate
Fig. 2: Broad Effective Exchange Rate for the U.S.

 

Related Readings

CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Calculating Foreign Exchange Spread
  • Currency Swap Contract
  • Foreign Exchange Gain/Loss
  • Trade-Weighted Exchange Rate

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