what does the real effective exchange rate reer tell you 
a country s reer is an important measure when assessing its trade capabilities reer can be used to measure the equilibrium value of a country s currency identify the underlying factors of a country s trade flow and analyze the impact that other factors such as competition and technological changes have on a country and ultimately on the trade weighted index for example if the u s dollar exchange rate weakens against the euro u s exports to europe will become cheaper european businesses or consumers buying u s goods need to convert their euros to dollars to buy our exports if the dollar is weaker than the euro it means europeans can get more dollars for each euro as a result u s goods get cheaper due solely to the exchange rate between the euro and the u s dollar the u s has a substantial trading relationship with europe because of this the euro to u s dollar exchange would have a larger weighting in the index a big move in the euro exchange rate would impact the reer more than if another currency with a smaller weighting strengthened or weakened against the dollar example of real effective exchange rate reer let s say the u s had a foreign trading relationship with only three parties the eurozone great britain and australia that means the u s dollar has a trading relationship with the euro the british pound and the australian dollar in this hypothetical example the u s does 70 of its trading with the eurozone 20 with great britain and 10 with australia the basket of currencies in this case would also hold the same percentages with the euro at 70 the british pound at 20 and the australian dollar at 20 a move in the euro would have a greater impact on the basket than a move in the australian dollar if one of the exchange rates moved significantly but the weighted average of the basket didn t change it could mean that the other currencies moved in the opposite direction offsetting the move of the first currency reer vs spot exchange ratea spot exchange rate is the current price to exchange one currency for another for delivery on the earliest possible value date the value date is the effective date for a financial transaction involving an asset that fluctuates in price although the spot exchange rate is for delivery on the earliest date the standard settlement date for most spot transactions is two business days after the transaction date the spot exchange rate therefore is a current market price the reer is an indicator of the value of a currency in relation to its trading partners limitations of the real effective exchange rate reer factors besides trade can impact the reer the real effective exchange rate doesn t take into account price changes tariffs or other factors that may affect trade between nations if prices are higher in one country compared with another the trade might decrease in the country with higher prices impacting its reer the weighting used in the reer calculation then has to be adjusted to reflect any changes in trade in addition the central bank of each nation adjusts its monetary policy which can lower or raise interest rates in the home country the flow of money could increase to countries with higher rates as investors chase yield thus strengthening the currency exchange rate the reer would be impacted but it would have little to do with trade and more to do with the interest rate markets economists use reer to evaluate a country s trade flow and analyze the impact that factors such as competition and technological changes are having on a country and its economy 