Example of Trade-Weighted Exchange Rate
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 Excel icon (16x16) 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 2005 value. This creates real exchange rate indexes with a 2005 base year equal to 100. Finally, we multiply each of the real exchange rate indexes by it import share, Australia at 62 percent and New Zealand at 38 percent, to get the trade-weighted index. The combined index is a weighted average of the two country indexes.