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posted on 21 June 2015

Understanding Recent Exchange-Rate Movements

by Dallas Fed

The international purchasing power of the euro area declined 16 percent and that of Japan fell 13 percent relative to the U.S. from July 2014 to last February.

Those drops signify a change in relative prices between countries, an important indicator of the attractiveness of imports and exports and also of relative standards of living. The international purchasing power of a country is measured by its real exchange rate (RER). In simplest terms, the RER is the nominal exchange rate (number of U.S. dollars needed to buy one unit of foreign currency) multiplied by the relative price level (euro-area price level/U.S. price level).

Evidence suggests that the recent fluctuations of the euro area and Japanese RERs are consistent with theories of the RER determination. Recent exchange rate fluctuations are a temporary part of a longer normalization and adjustment process.

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