What does an increase in the real effective exchange rate signify? I read from a news report that (localized for India):
Furthermore, REER is calculated in such a way that an increase in its value signifies appreciation of the rupee. If we assume that the rupee was “fairly" priced in the base year (when the index was set to 100, currently 2004-05), REER of more than 100 indicates that the rupee is overvalued. Since the current value of the trade-weighted REER index is around 115, we see several experts claiming that the rupee is 15% overvalued.
I understand that the REER is calculated using:
- Bilateral real exchange rate with various trading partners
- Weights assigned to these rates according to trade activity
But, I still can't understand what exactly an increase in REER means. If it increases by 10% (say), what exactly does it mean on the ground? And why is it overvalued if it's above 100 -- does that mean a currency is never rightly valued if it's not constant at 100? That'd mean that the REER shouldn't change at all from the base year --- otherwise a currency is never rightly valued. How can that happen?