REER and NEER (A2 Macroeconomics)

REER and NEER

NEER

This refers to the nominal effective exchange rate, it is a measure of the percentage change in a currency’s value. It is known as the nominal exchange because it only calculates the numerical exchange value, it ignores the purchasing power of the currency (which is a theory that explains why people in India for example can live off the average wage of £3,850 a year, after exchanging Rupees to £’s). The nominal effective exchange rate of a currency is determined by the government under a fixed exchange policy and by the supply and demand of the currency for a floating exchange rate system. 

Extract 4 from the pre-release material for OCR Econ 4 includes a graph which illustrates a 50% fall in Iceland’s NEER, this is a steep depreciation. This means that the Icelandic Krona could only purchase half of the amount British pounds in 2011 that it could in 2007. This was caused by the drastic fall in demand for the Krona when the Icelandic banks collapsed during the world recession of 2008.

REER

The real effective exchange rate takes purchasing power into account and measures the change in prices that country’s demand for their exports. If a country’s real effective exchange rate falls it means that the price of their exports has fallen. 

In the same extract, it is highlighted that Latvia’s NEER was unchanged but experienced a 20% decrease of its REER, this was a result of the vigorous austerity policy Latvia implemented. Latvia carried out an internal devaluation by keeping wages low, the objective of this was to improve the international competitiveness of Latvia’s exports to soften the effect of the recession.