Explanation:

•  Correct Option: (a) Explanation: Statement 1 is correct: REER, or Real Effective Exchange Rate, builds upon NEER (Nominal Effective Exchange Rate) by incorporating in fl ation differentials among countries.
• While NEER presents the weighted average of a currency’s relative rates against multiple currencies, REER adjusts for price level differences by factoring in in fl ation rates.
• This inclusion offers a more comprehensive perspective on currency strength, especially considering both trading balances and in fl ation.
• Statement 2 is correct: REER is a vital indicator of a country’s external trade competitiveness.
• A rising REER implies that, after accounting for exchange rates and in fl ation, a country’s goods and services may be pricier for foreign buyers.
• Conversely, a lower REER suggests increased competitiveness, making exports more attractive.
• Therefore, understanding REER shifts can provide insights into potential trade balance movements and the overall economic health.
• Statement 3 is incorrect: NEER represents the Nominal Effective Exchange Rate, offering a raw view of a country’s currency strength relative to a basket of other currencies.
• However, it doesn’t consider in fl ation, which can skew perceived competitiveness.
• REER addresses this by adjusting for in fl ation differentials, presenting a more accurate depiction of actual currency competitiveness.
• Thus, REER often provides a more insightful gauge of a country’s relative economic position than NEER alone.
• Supplementary Notes Nominal Effective Exchange Rate (NEER) An index representing the relative value of a currency against a weighted average of several foreign currencies.
• It is “nominal” because it doesn’t adjust for price level differences (in fl ation rates) among countries.
• Real Effective Exchange Rate (REER) An adjusted version of NEER that takes into account the in fl ation rate of the country and its trading partners.
• It provides a more accurate representation of a country’s currency’s value and competitiveness.
• Both indices are crucial for policymakers, especially in countries heavily reliant on exports or imports, as they re fl ect the relative price level of a country’s goods compared to its trading partners.