Why real exchange rates?

Most people are familiar with the nominal exchange rate, the price of one currency in terms of another. It's usually expressed as the domestic price of the foreign currency. That's where the real exchange rate (RER) comes in. It seeks to measure the value of a country's goods against those of another country, a group of countries, or the rest of the world, at the prevailing nominal exchange rate. In the real world, there are many costs that get in the way of a straight price comparison -- such as transportation costs and trade barriers. But the fundamental notion is that when RERs diverge, the currencies face pressure to change. RER indexes between two countries can be important. The massive US trade deficit with China has become a political and economic issue, and whether its roots are in a fundamentally misaligned exchange rate is a point of contention.