Question

What drives the Real Exchange Rate - is it changes in the price of Non tradables or the nominal exchange rate

Answer 1

The real exchange rate can be defined as the nominal exchange rate that takes the inflation differentials among the countries into account. Its importance stems from the fact that it can be used as an indicator of competitiveness in the foreign trade of a country.

The Real Exchange Rate between two currencies is the product of the nominal exchange rate (the dollar cost of a euro, for example) and the ratio of prices between the two countries

While the nominal exchange rate tells how much foreign currency can be exchanged for a unit of domestic currency, the real exchange rate tells how much the goods and services in the domestic country can be exchanged for the goods and services in a foreign country.

An improvement in the trade balance is associated with a fall in the relative price of non-tradable goods and services. The elimination of nominal exchange rates with the euro does not change these relationships

The nominal exchange rate is the relative price of two monies(money). ... Real exchange rates influence the trade balance. When there is a change in either domestic saving or domestic investment, the real exchange rate must adjust to produce an equivalent change in the current account balance.

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.

if it costs a U.S. dollar holder $1.36 to buy one euro, from a euro holder's perspective the nominal rate is 0.735.

The person, or firm, who buys another currency is interested in what can be bought with it. Are they better off with dollars or euros? That's where the Real Exchange Rate 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.