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Real Exchange Rates

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Nominal versus Real Exchange Rates
When discussing international trade and foreign exchange, two types of exchange rates are used. The nominal exchange rate simply states how much of one currency can be traded for a unit of another currency. The real exchange rate, on the other hand, describes how many of a good or service in one country can be traded for one of that good or service in another country. For example, a real exchange rate might state how many European bottles of wine can be exchanged for one US bottle of wine.

This is, of course, a bit of an oversimplified view of reality- after all, there are differences in quality and other factors between the US wine and the European wine. The real exchange rate abstracts away these issues, and it can be thought of as comparing the cost of equivalent goods across countries.

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