Effective Exchange Rates in Central and Eastern European Countries: Cyclicality and Relationship with Macroeconomic Fundamentals

This paper provides direct empirical evidence on the nature of the relationship between effective exchange rates and selected macroeconomic fundamentals in nine central and Eastern European countries. Therefore, the paper addresses a key precondition of numerous exchange rate determination models and theories that will explain the role of exchange rates in the economy. Additionaly, short-term volatility and medium-term variability of effective exchange rates are examined. The results suggest that flexible exchange rate arrangements are reflected in higher volatility and variability of nominal as well as real effective exchange rates. Furthermore, the results provide mixed evidence in intensity, direction and cyclicality but show a weak correlation between exchange rates and fundamentals. Sufficiently high coefficients are found only for the money supply. Consequently, using fundamentals for the determination of exchange rates and using the exchange rate for an explanation of economic development can be limited for the countries analyzed.