Summary
This article delves into the ongoing debate between nominal and real exchange rates, offering a critical analysis of expert perspectives while applying practical calculations to evaluate the real exchange rate (RER) for Guyana. The discussion highlights the theoretical underpinnings along with the inherent challenges of their application due to discrepancies in the Consumer Price Index (CPI) comparability, weighting differences, and sectoral misalignment. Through a practical example using Guyana and U.S. data, the author demonstrates how adjusting for base year inconsistencies impact the interpretation of the RER. Ultimately, the article argues that while RER and REER are valuable analytical tools, their practical application is complicated and requires careful consideration of real-world factors.
Introduction
As the debate on the abovementioned subject continues, this author wishes to acknowledge the latest contribution to the discussion thereof by a University of Guyana (UG) economics student, Joel Walcott (Stabroek News edition dated April 18, 2025, titled “Maintaining a stable nominal exchange rate is economically sound and in Guyana’s best interest”). Walcott made some very important, pragmatic interventions on the topic for which this author’s commendations are offered. It is imperative, more so that this opportunity is seized to encourage more of these types of intelligently written essays on public policy issues from our young and vibrant university students of economics, fresh graduates and practitioners alike.
Readers may recall that economists Drs. Singh, Yhip and Gampat argued that it is the real exchange rate that matters, thus, the central bank should be targeting the real exchange rate instead of the nominal exchange rate. Particularly, Gampat wrote the following comments under this author’s letter in response to Dr. Yhip on the Stabroek News website:
“It is important to note that the official exchange rate (which the average of the selling rate of the three largest commercial banks that operate in the FX market) is applicable to OFFICIAL transactions – it is a fiction that it not observable in the FX market. All talk that the official exchange rate is “determined” by … is nonsense”.
Gampat was referring, therein, to my previous article1 in which it was demonstrated that the exchange rate is fluctuating within an acceptable, flexible band range of ±4%, using the commercial banks’ average mid-rate representing the average market rate and the Bank of Guyana’s exchange rate as the central rate to calculate the band range. There was never any reference to an official rate by this author, as Gampat suggested. Thereunder, Gampat continues:
“It is the real exchange rate that it is the real effective exchange rate (REER) that matters. And the REER has been appreciating because, so it is said, inflation rates of Guyana’s major trading partners are higher than that of Guyana…”.
It must be borne in mind that with all of the foregoing pontification by these three most seasoned and distinguished economists, regrettably, none of these esteemed gentlemen sought to substantiate their arguments by at least performing the calculations for the real exchange rate (RER) and real effective exchange rate (REER), respectively. Rather, they all seem fixated in their idiosyncratic comfort characterized by their inherently monotonous regurgitation of text book theories, albeit in abstraction, thereby failing collectively in the practical application department.
1 https://guyanachronicle.com/2025/04/17/it-is-disappointing-when-economists-fail-to-utilise-applied-economics-in- their-analyses/
Discussion and Analysis
The Real Exchange Rate and Real Effective Exchange Rate
By definition 2 , the RER measures the value of one currency against another, adjusted for differences in price levels (typically inflation or the Consumer Price Index (CPI) between two countries. On the one hand, the RER is used to compare the purchasing power of different currencies and to assess the competitiveness of a country’s goods and services in global markets. It helps us to understand the impact of inflation or exchange rates and the real value of the currency. On the other hand, the REER is a weighted average of a country’s currency relative to an index or basket of major currencies, adjusted for the effects of inflation. It provides a broader measure of a currency’s value compared to multiple trading partners.
Dr. Gampat suggests that the RER is the same as the REER, which is not necessarily the case. The REER builds on the RER, and the procedure to calculate the REER is much more complicated than the RER.
The formula for RER:
RER = Nominal Exchange Rate (NER) X Price Level in Foreign Country (Foreign Country’s CPI)
Price Level in Home Country (Home Country’s CPI)
The formula for REER:
Where:
- Nominal Exchange Ratei = the nominal exchange rate between the home currency and the ith foreign currency.
- Price level in foreign countryi = the CPI of the ith foreign country.
- Price level in home country = CPI in home country.
- w_i = the weight assigned to the ith foreign currency, often based on trade volumes.
In summary, the RER and the REER serve different but complementary purposes in economic analysis. While the RER is useful for understanding the real value of a currency against another specific currency, the REER provides a more comprehensive measure by considering multiple trading partners. Both are essential tools for assessing currency values, inflation impacts, and international competitiveness.
2 Source: (cited from Chat & Ask AI, Codeway, 2025)
Theory vs Practice: Practical Challenges Encountered when Calculating RER or REER
There are several practical challenges to consider in the calculations for the RER and REER. The mathematical equation assumes that the CPI for the home country is equally comparable to those of its trading partners. However, in practice and in reality, this is often times far-fetched. In this regard, other than issues of quality and coverage, which can become the subject of perpetual debates in some academic spheres, sometimes credibly so and sometimes not, there are other key discrepancies such as3:
- Comparability Issues: The United States (US) CPI includes a broader range of goods and services than the home country’s (Guyana) CPI. This means that the two indices would not be directly comparable, hence, leading to inaccurate adjustments for inflation.
- Weighting Differences: The CPI index comprises a number of sub-indices, each having a different degree of weighting in the overall CPI. In cases where the foreign country, as in the case of the United States versus Guyana, the weights of the sub- indices or each component in the CPI’s basket of goods may not be directly comparable, especially as in the case of the US whose CPI is broader in scope than Guyana’s.
- Sectorial Misalignment: If the US economy has a different sectoral composition compared to the home country, the CPI might reflect price changes in sectors that are not significant in the home country. For example, if the US CPI heavily weights technology products, but the home country’s economy is more focused on agriculture, the RER and REER might not accurately reflect relative purchasing power.
Other discrepancies may include inflation measurement bias, data availability and timeliness, and substitution bias.
RER Practical Example:
Having established the theoretical underpinnings of the RER and REER, let’s apply the RER formula in a real-world scenario4—to calculate the real exchange rate in Guyana relative to the United States dollar.
3 Source: (cited from AI generated source: Chat & Ask AI, Codeway, 2025)
4 For the purposes of the subsequent calculations, the author utilizes data for the year 2024, sourced from the relevant authoritative official sources (Guyana Bureau of Statistics and the US Bureau of Labor Statistics).
Given the RER formula as noted in the previous section, the following data is given:
- Guyana CPI: 143.5
- United States CPI: 315.6
- GYD/USD nominal rate: $220.31 (average midrate)
It should be noted that for the purpose of this demonstration and for simplicity, the author utilized the commercial banks’ average mid-rate representing the market rate for the nominal exchange rate. However, the calculations can be repeated using the different rates, namely the average buying rate (2024), which was $218.95. The real exchange rate for the buying rate is essentially the real exchange rate that importers will be subjected to; or the average selling rate (2024) of
$221.66, which exporters would be subjected to, or the Bank of Guyana rate (2024) of $208.5, which government transactions would be subjected to.
RER Calculation:
RER = (220.3 X 315.6)/143.5 = $484.5
According to this calculation, the real exchange rate is $484.5, but this is incorrect because there is a discrepancy with the base years between the two countries’ CPI. The CPI’s base year for the US is (1982-1984), whereas for Guyana, it is 2009. To resolve this discrepancy, we can adjust the US CPI base year to 2009 and then recalculate the CPI for 2024, inter alia, the following procedure:
In 2009, the US CPI was 214.5, which rose to 315.6 by the end of 2024. This means that the CPI reflected an increase of 101.1 or 47.1% during that period. Therefore, the base year can now be adjusted to 2009 (base year) = 100 or 100%, and the re-calculated CPI for 2024 will be 100 +
47.1 = 147.1. With this adjustment made to US CPI for consistency with Guyana’s base year and the comparable time horizon, the result can be interpreted this way:
In the US, prices have increased by 47.1% since 2009, and for the same period, prices have increased by 43.5% in Guyana.
Guyana’s RER can now be recalculated using the adjusted CPI for the US (2024):
RER = (220.3 X 147.1)/143.5 = $225.8. The RER derived in this calculation of $225.8 suggests that the real exchange rate is depreciating and not appreciating as Dr. Ramdas would have intimated in his commentary without performing the calculations and/or analysis. Another interpretation of the result is that the domestic currency is overvalued by 2.5%.
Notwithstanding the foregoing demonstration, the RER of $225.8 is highly unlikely to be an accurate reflection of the real exchange rate owing to the inherent comparability issues of the CPIs between the two countries, as well as weighting differences. The US CPI is much broader in scope and coverage in contrast to Guyana’s CPI, having examined the CPI data available on the US Bureau of Labor Statistics.
For example, the US CPI includes a sub-index for energy (energy commodities, fuel oil and other fuels, fuel, propane, kerosene, energy services, electricity and piped gas among others in this sub-category), as well as regional. In Guyana’s case, similar sub-categories are not included. Additionally, the other similar sub-categories such as food, clothing, housing and transportation, cover a wider range of goods and services.
With respect to the weights of each sub-category, measuring their relative importance in the overall index, housing carries the heaviest weight in the US CPI accounting for 43% of the overall index, food and beverage carries a weight of 14.3%, and medical care accounts for 9% of the CPI. Conversely, the food sub-category accounts for the largest weight in the Guyana’s CPI, according to the Bureau of Statistics.
Real Effective Exchange Rate: Local Context
Considering that the REER formula builds on the RER formula, and that several practical issues in its application to calculate the RER for Guyana relative to the US currency have been established, it is not worthwhile to move forward in this demonstration to calculate the REER. In fact, there are additional complexities to consider in the case of Guyana—that is, the formula as noted in the previous section, cannot be applied in a straight forward manner. The issue referred to herein pertains to the intermediary foreign currency, which is the USD, that is largely used to transact international trade with multiple trading partners. For example, Guyana’s top three (3) trading partners are the United States, China and Trinidad and Tobago whereby payments are rarely made, if at all, in those countries’ respective currencies: This reality further complicates the REER calculation.
Conclusion
The debate surrounding exchange rate dynamics underscores the importance of bridging economic theory with applied analysis. While some economists emphasize the real exchange rate as the key indicator, the practical complexities in deriving accurate measurements—such as CPI inconsistencies and intermediary currency considerations—suggest that the nominal exchange rate remains an essential reference point. This article demonstrates that a disciplined approach pragmatic application, rooted in precise calculations, country specific factors and localized contextualities, provide a more nuanced understanding of exchange rate behavior.