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91 Fed. Res. Bull. 1 (2005)
Indexes of the Foriegn Exchange Value of the Dollar

handle is hein.journals/fedred91 and id is 17 raw text is: Indexes of the Foreign Exchange Value
of the Dollar

Mico Loretan, of the Board's Division of Inter-
national Finance, prepared        this article. Autria
Mazda and Sarita Subramanian provided research
assistance.
At the end of 1998, the staff of the Federal Reserve
Board introduced a new set of indexes of the foreign
exchange value of the U.S. dollar.I The staff made the
changeover, from indexes that had been used since
the late 1970s, for two reasons. First, five of the ten
currencies in the staff's previous main index of the
dollar's foreign exchange value were about to be
replaced by a single new currency, the euro. Second,
developments in international trade since the late
1970s called for a broadening of the scope of the
staff's dollar indexes and a closer alignment of the
currency weights with U.S. trade patterns.
Exchange rate indexes aggregate and summarize
information contained in a collection of bilateral
foreign exchange rates. Choices concerning the
exchange rates to include, the formula to use in
combining the component exchange rates into a
single number, and the weights to assign the
exchange rates in an index all depend importantly on
the objectives of the index. The main objective of the
staff's current indexes is to summarize the effects of
dollar appreciation and depreciation against foreign
currencies on the competitiveness of U.S. products
relative to goods produced by important trading part-
ners of the United States. The staff also uses some
of the indexes-those that track the dollar's moves
1. See Michael P Leahy (1998), New Summary Measures of the
Foreign Exchange Value of the Dollar, Federal Reserve Bulletin,
vol. 84 (October), pp. 811-18. That article, the tune series of the
dollar indexes, and the time series of the currency weights are avail-
able on line at the Board's public website (www.federalreserve.gov).
Values of the dollar indexes for recent months and years also appear
in table 3.28 of the monthly Statistical Supplement to the Federal
Reserve Bulletin and are available through several financial news
services. Earlier Bulletin articles on exchange rate indexes include
B. Dianne Pauls (1987), Measuring the Foreign Exchange Value of
the Dollar, vol. 73 (June), pp. 411-22; Peter Hooper and John
Morton (1978), Summary Measures of the Dollar's Foreign
Exchange Value, vol. 64 (October), pp. 783-89; and Index of the
Weighted-Average Exchange Value of the U.S. Dollar: Revision
(1978), vol. 64 (August), p. 700.

against only the major foreign currencies-to gauge
financial market pressures on the dollar.
To capture the evolving nature of international
trade patterns, the staff's current exchange rate
indexes allow changes in the component exchange
rates and their weights. The currency weights in the
dollar indexes are based on annual trade data, vary by
year, and have been updated annually since 1998.
Although the set of exchange rates in the indexes has
remained unchanged so far, the staff will continue to
review whether changes in composition or methodol-
ogy are needed to ensure that the indexes adequately
reflect ongoing developments in international trade
patterns.
Several practical aspects of the design and imple-
mentation of the current indexes-the choice of index
formula, the design of currency weights, and the
selection of currencies-are discussed in this article.
The article also reviews the performance of the
indexes over the past twenty-five years and discusses
the three minor methodological changes that the
indexes have undergone since their introduction.
CHOICE OF INDEX FORMULA
The practice followed by the staff of the Board and
by that of several other central banks, international
organizations, and private-sector financial institutions
is to use exchange rate indexes that are geometrically
weighted averages of bilateral exchange rates.2 The
Board staff's nominal dollar exchange rate index at
time t, I, is
N(t)
I = It- x  eti,q'ej,t- 1  ,
j=1
2. For more information on various index forms and their math-
ematical properties, see W. Erwin Diewert (1987), Index Numbers,
in John Eatwell, Murray Milgate, and Peter K. Newman, eds., The
New Palgrave: A Dictionary of Economics, vol. 2 (New York: Stock-
ton), pp. 767-80. For descriptions of the sterling and euro exchange
rate indexes currently used, for example, by the staff of the Bank of
England and the European Central Bank, see Birone Lynch and Simon
Whitaker (2004), The New Sterling ERI, Bank of England Quar-
terly Review (Winter), pp. 429-41; and Effective Exchange Rate of
the Euro (2004), European Central Bank Monthly Bulletin (Septem-
ber), pp. 68-72.

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