Example of How a Trade-Weighted Exchange Rate Is Derived
To demonstrate the process of deriving a trade-weighted
exchange rate index, actual exchange rate data from Australia
and New Zealand are used here to develop a supplier index
for lamb imports. Virtually all U.S. lamb imports come
from Australia and New Zealand. Thus, the approximate
lamb index is averaged for just those two countries. The
process for generating the index is the same whether there
are two or 200 countries.
We take the nominal exchange rates for Australia and
New Zealand in local currency per U.S. dollar and multiply
by the ratio of the U.S. Consumer Price Index to the Australian
and New Zealand Consumer Price indexes (see
Excel
table). This gives us real exchange rates. We next
convert the real exchange rates into index form by dividing
each of the series by the 2005 value. This creates real
exchange rate indexes with a 2005 base year equal to 100.
Finally, we multiply each of the real exchange rate indexes
by it import share, Australia at 62 percent and New Zealand
at 38 percent, to get the trade-weighted index. The combined
index is a weighted average of the two country indexes.
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