About the data
4.16
Definitions
In a market-based economy, household, producer,
effective exchange rate index and a cost indicator
• Official exchange rate is the exchange rate deter-
and government choices about resource allocation
of relative normalized unit labor costs in manufactur-
mined by national authorities or the rate determined
are influenced by relative prices, including the real
ing. For selected other countries the nominal effec-
in the legally sanctioned exchange market. It is cal-
exchange rate, real wages, real interest rates, and
tive exchange rate index is based on manufactured
culated as an annual average based on monthly
other prices in the economy. Relative prices also
goods and primary products trade with partner or
averages (local currency units relative to the U.S.
largely reflect these agents’ choices. Thus relative
competitor countries. For these countries the real
dollar). • Purchasing power parity (PPP) conversion
prices convey vital information about the interaction
effective exchange rate index is the nominal index
factor is the number of units of a country’s currency
of economic agents in an economy and with the rest
adjusted for relative changes in consumer prices; an
required to buy the same amount of goods and ser-
of the world.
increase represents an appreciation of the local cur-
vices in the domestic market that a U.S. dollar would
The exchange rate is the price of one currency
rency. Because of conceptual and data limitations,
buy in the United States. • Ratio of PPP conver-
in terms of another. Offi cial exchange rates and
changes in real effective exchange rates should be
sion factor to market exchange rate is the result
exchange rate arrangements are established by
interpreted with caution.
obtained by dividing the PPP conversion factor by the
governments. Other exchange rates recognized by
Inflation is measured by the rate of increase in a
market exchange rate. • Real effective exchange
governments include market rates, which are deter-
price index, but actual price change can be nega-
rate is the nominal effective exchange rate (a mea-
mined largely by legal market forces, and for coun-
tive. The index used depends on the prices being
sure of the value of a currency against a weighted
tries with multiple exchange arrangements, principal
examined. The GDP deflator reflects price changes
average of several foreign currencies) divided by
rates, secondary rates, and tertiary rates.
for total GDP. The most general measure of the over-
a price deflator or index of costs. • GDP implicit
Official or market exchange rates are often used
all price level, it accounts for changes in government
deflator measures the average annual rate of price
to convert economic statistics in local currencies to
consumption, capital formation (including inventory
change in the economy as a whole for the periods
a common currency in order to make comparisons
appreciation), international trade, and the main com-
shown. • Consumer price index reflects changes
across countries. Since market rates reflect at best
ponent, household final consumption expenditure.
in the cost to the average consumer of acquiring a
the relative prices of tradable goods, the volume of
The GDP deflator is usually derived implicitly as the
basket of goods and services that may be fixed or
goods and services that a U.S. dollar buys in the
ratio of current to constant price GDP—or a Paasche
may change at specified intervals, such as yearly.
United States may not correspond to what a U.S.
index. It is defective as a general measure of inflation
The Laspeyres formula is generally used. • Whole-
dollar converted to another country’s currency at
for policy use because of long lags in deriving esti-
sale price index refers to a mix of agricultural and
the official exchange rate would buy in that country,
mates and because it is often an annual measure.
industrial goods at various stages of production and
particularly when nontradable goods and services
Consumer price indexes are produced more fre-
account for a significant share of a country’s output.
quently and so are more current. They are also con-
An alternative exchange rate—the purchasing power
structed explicitly, based on surveys of the cost of
parity (PPP) conversion factor—is preferred because
a defined basket of consumer goods and services.
it reflects differences in price levels for both tradable
Nevertheless, consumer price indexes should be
and nontradable goods and services and therefore
interpreted with caution. The definition of a house-
provides a more meaningful comparison of real out-
hold, the basket of goods, and the geographic (urban
put. See table 1.1 for further discussion.
or rural) and income group coverage of consumer
The ratio of the PPP conversion factor to the official
price surveys can vary widely by country. In addi-
exchange rate—the national price level or compara-
tion, weights are derived from household expendi-
tive price level—measures differences in the price
ture surveys, which, for budgetary reasons, tend to
level at the gross domestic product (GDP) level. The
be conducted infrequently in developing countries,
price level index tends to be lower in poorer countries
impairing comparability over time. Although useful for
and to rise with income.
measuring consumer price inflation within a country,
The real effective exchange rate is a nominal effective exchange rate index adjusted for relative
distribution, including import duties. The Laspeyres formula is generally used.
consumer price indexes are of less value in comparing countries.
movements in national price or cost indicators of
Wholesale price indexes are based on the prices at
the home country, selected countries, and the euro
the first commercial transaction of commodities that
area. A nominal effective exchange rate index is the
are important in a country’s output or consumption.
ratio (expressed on the base 2005 = 100) of an
Prices are farm-gate for agricultural commodities and
Data on official and real effective exchange rates
index of a currency’s period-average exchange rate
ex-factory for industrial goods. Preference is given to
and consumer and wholesale price indexes are
to a weighted geometric average of exchange rates
indexes with the broadest coverage of the economy.
from the International Monetary Fund’s Interna-
for currencies of selected countries and the euro
The least squares method is used to calculate
tional Financial Statistics. PPP conversion factors
area. For most high-income countries weights are
growth rates of the GDP implicit deflator, consumer
and GDP deflators are from the World Bank’s data
derived from industrial country trade in manufac-
price index, and wholesale price index.
files.
Data sources
tured goods. Data are compiled from the nominal
2012 World Development Indicators
277
ECONOMY
Exchange rates and prices