What is an effective exchange rate?

An effective exchange rate is the value of a currency measured against a weighted basket of the currencies of its main trading partners, expressed as an index.

What does an effective exchange rate index value of 100 represent?

It represents the currency's value in the chosen base period, against which all later values are compared.

An effective exchange rate index rises from 92.0 to 96.6. Calculate the percentage appreciation.

The currency has appreciated by 5.0%.

Edexcel A-Level Economics B 9EB0

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Reading exchange rate and effective exchange rate data

3 things to know
Papers 2 and 3

Overview

Recall questions on the effective exchange rate and its weighting, what an index of 100 means, calculating appreciation and depreciation, and reading a quoted rate the right way round.

What you need to know

Answer each one before you reveal it.

Your recallNot started

Key term

Why are the currencies in an effective exchange rate index weighted?

Key term

Why is an effective exchange rate more informative than a single bilateral rate?

Numbers

An effective exchange rate index falls from 85.0 to 78.2. Calculate the percentage change to one decimal place.

Questions from this subtopic

Each one with the model answer underneath.

1
What is an effective exchange rate?
Model answer
An effective exchange rate is the value of a currency measured against a weighted basket of the currencies of its main trading partners, expressed as an index.
2
Why are the currencies in an effective exchange rate index weighted?
Model answer
Each currency is weighted by that partner's share of the country's trade, so movements against major trading partners count for more than movements against minor ones.
3
Why is an effective exchange rate more informative than a single bilateral rate?
Model answer
A currency can rise against one currency while falling against others, so only a trade-weighted index shows whether it has strengthened overall.
4
What does an effective exchange rate index value of 100 represent?
Model answer
It represents the currency's value in the chosen base period, against which all later values are compared.
5
An effective exchange rate index falls from 85.0 to 78.2. Calculate the percentage change to one decimal place.
Model answer
The index has fallen by 8.0%.
6
An effective exchange rate index rises from 92.0 to 96.6. Calculate the percentage appreciation.
Model answer
The currency has appreciated by 5.0%.

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