Definitions and Implications of Real Currency Exchange Rate (RCER)

This chapter proposes to define the real exchange rate of a currency as the nominal exchange rate adjusted for relative purchase power. It measures how much the currency can purchase in real terms, or the purchase power of the currency abroad relative to that at home. According to the literature, the relative national price levels of two economies are known as the real exchange rate (RER), and the nominal exchange rate that corresponds to it serves as a means of converting the units of account so that two price levels can be assessed in the same currency. Its topic is the relative cost of living in two economies, not the value or exchange rate. The subject is the currency which serves as medium of exchange. It implies that its measure should be asymmetric; the price at home is broad like CPI, but the price abroad is only for imports. We hypothesize that under our proposed definition for the real exchange rate the modified Marshall-Learner condition could be more relaxed than its original version. Of course, this hypothesis is subject to test.