Real Exchange Rate Misalignment in the Euro Area: Is the Current Development Helpful?

We use the behavioral equilibirum exchange rate (BEER) approach to examine the extent of real exchange rate misalignment in the euro area over the period 1980-2014. In a panel data setting, we find significant links between real exchange rates, relative productivity, trade balance and terms of trade. All else equal, a 2 percent increase in the trade surplus as a ratio to GDP translates to a 1 percent real depreciation. A real productivity gain by 5 percent is associated with, ceteris paribus, 1 percent real appreciation. Finally, an increase in terms of trade by 2.5 percent leads to 1 percent real appreciation, all else equal. We also show the extent of overvaluation in peripheral countries of the euro area has been increasing since mid-2000s. This trend stopped in the latter part of the studied period as inflationary differentials in these countries became negative. We discuss implications of such reversal and conclude the current situation might be helpful when restoring competitiveness in the euro area periphery.