Nominal Effective Exchange Rate (NEER) Definition - Investopedia

What Is the Nominal Effective Exchange Rate (NEER)?

The nominal effective exchange rate (NEER) is an unadjusted weighted average rate at which one country's currency is exchanged for a basket of multiple foreign currencies. The nominal exchange rate is the amount of domestic currency that's needed to purchase foreign currency.

The NEER is an economic indicator of a country's international competitiveness in terms of the foreign exchange (forex) market. Forex traders sometimes refer to the NEER as the trade-weighted currency index.

The NEER can be adjusted to compensate for the inflation rate of the home country relative to the inflation rate of its trading partners. The resulting figure is the real effective exchange rate (REER). NEER isn't determined for each currency separately unlike the relationships in a nominal exchange rate. One individual number, typically an index, instead expresses how a domestic currency’s value compares against multiple foreign currencies at once.

Key Takeaways

• The NEER is an economic indicator of a country's international competitiveness in terms of the foreign exchange (forex) market.
• It can be adjusted to compensate for the inflation rate of the home country relative to the inflation rate of its trading partners.
• The NEER only describes relative value.
• It's used in economic studies and for policy analysis on international trade as well as by forex traders.

What Does the Nominal Effective Exchange Rate (NEER) Tell You?

The NEER describes only relative value. It can't definitively show whether a currency is strong or gaining strength in real terms. It only describes whether a currency is weak or strong or weakening or strengthening compared to foreign currencies. The NEER can help identify which currencies store value more or less effectively. Exchange rates influence where international actors buy or sell goods.

The NEER is used in economic studies and for policy analysis on international trade. It's also used by forex traders who engage in currency arbitrage. The Federal Reserve calculates three NEER indices for the United States: the broad index, the Advanced Foreign Economies (AFE), and the Emerging Market Economies (EME).

The Basket of Foreign Currencies

Every NEER compares one individual currency against a basket of foreign currencies. This basket is chosen based on the domestic country's most important trading partners as well as other major currencies.

The world's top five major currencies are the U.S. dollar, the British pound, the Euro, the Japanese yen, and the Swiss franc.

The value of foreign currencies in a basket is weighted according to the value of trade with the domestic country. This could be export or import value, the total value of exports and imports combined, or some other measure. The weights often relate to the assets and liabilities of different countries.

A higher NEER coefficient above one means that the home country's currency is usually worth more than an imported currency. A lower coefficient below one means that the home currency is usually worth less than the imported currency.

There's no international standard for selecting a basket of currencies. The Organization for Economic Co-operation and Development (OECD) basket is different from the baskets of the International Monetary Fund (IMF), the Federal Reserve, or the Bank of Japan. Many institutions rely on the International Financial Statistics (IFS) published by the IMF, however.

What Is the Trade-Weighted Exchange Rate?

The trade-weighted exchange rate measures a country's currency exchange rate by incorporating the trades it enters into with other countries. It's a complicated equation because it inputs the weights of shares of the currencies of other countries that each country trades with.

Can the NEER Change Through Appreciation or Depreciation?

The NEER is said to appreciate if a domestic currency increases against a basket of other currencies inside a floating exchange rate regime. The NEER depreciates if the domestic currency falls against the basket.

What Is the Strongest Currency in the World in 2024?

Forbes Advisor gives the honor to the Kuwaiti dinar. One U.S. dollar equaled 0.31 dinar as of October 2024. The British pound came in at fifth place and the U.S. dollar was tenth at that time.

The Bottom Line

The nominal effective exchange rate (NEER) is an economic indicator of a country's international competitiveness in terms of the foreign exchange (forex) market. It’s an unadjusted weighted average rate at which one country's currency is exchanged but it can be adjusted to compensate for the inflation rate of the home country.

The NEER is used in economic studies and policy analysis but it’s also used by forex traders. Consider working with an expert forex broker before you begin using it so you have guidance.