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Long-run determinants and misalignments of the real effective exchange rate in the EU

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  • Mariarosaria Comunale

    () (Bank of Lithuania)

Abstract

Exchange rate assessment is becoming increasingly relevant for economic surveillance in the European Union (EU). The persistence of different wage, price and productivity dynamics among the Economic and Monetary Union (EMU) countries or EU members with a fixed exchange regime with the euro, coupled with the impossibility of correcting competitiveness differentials via the adjustment of nominal rates, have resulted in divergent dynamics in Real Effective Exchange Rates. This paper explores the role of economic fundamentals, included in the transfer effect theory, in explaining medium/long-run movements in the Real Effective Exchange Rates in the EU over the period 1994–2012 by using heterogeneous, co-integrated panel frameworks in static and dynamic terms. In addition, the paper provides an analysis of the misalignments of the rate for each member state based on the “equilibrium” measure calculated from the permanent component of the fundamentals (the so-called Behavioural Effective Exchange Rate). We find that the coefficients of the determinants are extremely different across groups in magnitude and sometimes in sign as well and the transfer theory does not hold for periphery and the Central and Eastern European countries (CEECs). The relative importance of the transfer variable and the Balassa-Samuelson measure are crucial for the asymmetries. The resulting misalignments in EU28 are huge and the patterns diverge significantly across groups. The core countries have been undervalued for almost the whole period, which entails from an important increase in competitiveness for those countries. Instead the periphery has experienced high rates, especially in Portugal. In addition, the behaviour of CEECs is also driven, as expected, by the catching-up process and the criteria to the accession to the EU. The misalignments in this case are still extremely wide and reflect these phenomena.

Suggested Citation

  • Mariarosaria Comunale, 2015. "Long-run determinants and misalignments of the real effective exchange rate in the EU," Bank of Lithuania Working Paper Series 18, Bank of Lithuania.
  • Handle: RePEc:lie:wpaper:18
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    Citations

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    Cited by:

    1. Mariarosaria Comunale, 2016. "A Closer Look at EU Current Accounts," CEIS Research Paper 393, Tor Vergata University, CEIS, revised 11 Aug 2016.
    2. Mariarosaria Comunale, 2017. "A panel VAR analysis of macro-financial imbalances in the EU," Bank of Lithuania Working Paper Series 40, Bank of Lithuania.
    3. Comunale, Mariarosaria, 2017. "Dutch disease, real effective exchange rate misalignments and their effect on GDP growth in EU," Journal of International Money and Finance, Elsevier, vol. 73(PB), pages 350-370.
    4. repec:bof:bofitp:urn:nbn:fi:bof-201510131420 is not listed on IDEAS
    5. Fidora, Michael & Giordano, Claire & Schmitz, Martin, 2017. "Real exchange rate misalignments in the euro area," Working Paper Series 2108, European Central Bank.
    6. Mariarosaria Comunale, 2015. "Current Account and Reer Misalignments in Central Eastern EU Countries: an Update Using the Macroeconomic Balance Approach," Bank of Lithuania Working Paper Series 20, Bank of Lithuania.
    7. Mariarosaria Comunale, 2016. "Dutch disease, real effective exchange rate misalignments and their effect on GDP growth in the EU," CAMA Working Papers 2016-28, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    8. Mariarosaria Comunale & Jonas Striaukas, 2017. "Unconventional monetary policy: interest rates and low inflation: A review of literature and methods," CAMA Working Papers 2017-29, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    9. Comunale, Mariarosaria, 2018. "Current account and real effective exchange rate misalignments in Central Eastern EU countries: An update using the macroeconomic balance approach," Economic Systems, Elsevier, vol. 42(3), pages 414-436.
    10. Gordana Kordic, 2015. "Post-Transition Monetary and Exchange Rate Policies: Dilemmas on Eurozone membership in terms of Global Recession," MIC 2015: Managing Sustainable Growth; Proceedings of the Joint International Conference, Portorož, Slovenia, 28–30 May 2015, University of Primorska, Faculty of Management Koper.
    11. Claire Giordano, 2018. "Price and cost competitiveness misalignments of the euro area and of its main economies according to a quarterly BEER model, 1999-2017," Questioni di Economia e Finanza (Occasional Papers) 444, Bank of Italy, Economic Research and International Relations Area.

    More about this item

    Keywords

    real effective exchange rate; European Union; behavioural effective exchange rate; transfer problem; panel co-integration; exchange rate misalignments;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models

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