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 1995
value. This creates real exchange rate indexes with a 1995 base year equal
to 100. Finally, we multiply each of the real exchange rate indexes by
it import share, Australia at 61 percent and New Zealand at 39 percent,
to get the trade-weighted index. The combined index is a weighted average
of the two country indexes.
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