Note that much IMF data specifies exchange rates with respect to the US dollar and its own 'reserve claims' - Special Drawing Rights or SDRs.

SDRs

The IMF has issued a number of claims called Special Drawing Rights to member countries which entitle them to purchase other currencies for use in protecting their own currency. The 'rates' at which SDRs can be converted to other currencies are the SDR exchange rates. These are calculated on the basis of a weighted average of the dollar exchange rates of the four key world currencies (dollar, euro, yen, pound sterling) taken daily at noon in the London currency market. The weighting is based on the relative use of each of these 4 currencies in international transactions. It is determined by the IMF every 5 years.

The rate for a particular currency can be calculated using its dollar exchange rate. For each other currency, the rate is a very rough average of the rate they can trade at across these key currencies. However, whilst the SDR rate is important for IMF dealings, including the calculation of interest rates on IMF loans, it is seldom used in market transactions or as a basis for national exchange rate policy. Most importantly, since the weighting given to each key currency is not likely to match the trading patterns of any particular country, it is of little value in making international comparisons.

Effective Exchange Rates.

Market exchange rates are bilateral - comparing the value of two currencies against each other. However, much comparative research seeks to compare the general trading situations of a number of countries.

Indeed any particular country may be more interested in how its exchange rate is behaving in relation to all its trading partners rather than to any single one of them. Commonly this is measured by a country's trade weighted exchange rate.

Nominal Effective Exchange Rate

In simplest index form, the trade weighted exchange rate can be found as a set of Nominal Effective Exchange Rates (NEER) in several databanks in the UK Data Service international macro data collection. A country's NEER is a weighted average of its currency exchange rates with its major trading partners' currencies. The weightings will be based on the level of trade with each trading partner. Thus a NEER gives a much better view of changes in a country's terms of trade with the rest of the world than bilateral or SDR rates.

A country whose NEER is falling, is trading internationally on worsening terms; it is costing that country more to buy goods and services from abroad.

Real Effective Exchange Rate

An important refinement of the NEER is the Real Effective Exchange Rate (REER). This is particularly useful in considering comparative changes in a country's real economic circumstances. If the spot market rate for a country or its NEER shows a downward trend this could be because other countries are becoming relatively more productive. But it could arise from a difference in inflation rates between that country and others in the world. The REER is a NEER with price or labour cost inflation removed. It is thus a better measure of comparative economic activity between countries than simple market rates.

Comparability of Effective Exchange Rates

Comparing two effective rates at one point in time gives no useful information. The initial values of exchange rates are arbitrary. They depend on the unit of currency chosen. Suppose the dollar/ sterling exchange rate were $1.5 per £ sterling. Suppose the euro dollar exchange rate was $1.2 per euro. This doesn't mean that sterling holders are better off than euro holders. Suppose that the sterling/dollar rate was to be denominated in sterling pence and US dollars. The dollar/sterling exchange rate would now be $0.015 per penny. Only denominated units would have changed giving a lower number to the sterling exchange rate compared to the euro rate, but of course sterling holders are neither richer nor poorer than euro holders as a result!