Methodologies for the Assessment of Real Effective Exchange Rates

This paper develops benchmarks to assess relative price developments based on the so-called behavioural equilibrium exchange rate (BEER) empirical models. Predictions from these empirical models for the determinants of real effective exchange rates allow estimating REER benchmarks consistent with the fundamentals of the economy. While relative price assessments are commonly based on REER indexes, index numbers do not permit comparisons across countries, so that benchmarks based on indexes cannot account for cross-country relations in economic fundamentals, including catching-up effects. To account for this, complementary benchmarks are also developed for the REER in levels. To this purpose, REER measures comparable across countries are constructed using purchasing power parities from the World Bank International Comparison Program, following a regression framework akin to that in Cubeddu et al. (2018), performed on a larger panel of countries and following a different criterion for the definition of the economic fundamentals to compute REER benchmarks. These benchmarks complement those based on current account gaps, already used in economic surveillance under the Macroeconomic Imbalance Procedure, to enrich the overall assessment of exchange rate positions and dynamics.