Long-Run Determinants and Misalignments of the Real Effective Exchange Rate in the EU

Abstract

Exchange rate assessment is becoming increasingly relevant for economic surveillance in the EU. The persistence of different wage and productivity dynamics among EMU countries or EU members with a fixed exchange regime with euro, coupled with the impossibility of correcting competitiveness differentials via the adjustment of nominal rates, have resulted into divergent dynamics in Real Effective Exchange Rates. This paper explores the role of economic fundamentals in explaining medium/long-run movements in the Real Effective Exchange Rates in the European Union over the period 1994-2012 by using heterogeneous, cointegrated 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 (BEER). The misalignments in EU28 are huge and the patterns differ significantly among groups. Therefore, despite the influence of the fundamentals is quite similar, the differences in the transfer variable (which affect the BEER) and in the actual Real Effective Exchange Rate are key. 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 behavior of CEECs is driven, as expected, by the transition process and influenced by the criteria to the accession to the EU. The misalignments in this case are still extremely wide and reflect these phenomena.

Current Account and Reer Misalignments in Central Eastern EU Countries: An Update Using the Macroeconomic Balance Approach

“…20 The result for the FDI/GDP coefficient is very robust. We find the same outcome both in sign and magnitude, if we run the regression as in Column (1) Concerning the misalignments of CA and REER, these are very different from those generated by the BEER method (as in Comunale, 2015). The difference in misalignments between Lee's approach and Medina's are mainly in magnitude instead.…”

“…The IMF CGER consists of three different methodologies to calculate the misalignments: Macroeconomic Balance approach, a reduced-form "equilibrium real exchange rate" approach, and an "External Sustainability" approach. An analysis based on the reduced-form equilibrium real exchange rate approach for the EU28 and the CEECs is provided in Comunale (2015). We decided to apply the CGER methodology instead of the new External Balance Assessment (EBA) because the latter, which takes into account a much broader set of factors (including policies, cyclical conditions, and global capital market conditions) that may influence the current account and real exchange rate, does not provide a theoretical foundation for their inclusion in the setups all together, which may raise issues for the econometric analysis of CA determinants.…”

Dutch disease, real effective exchange rate misalignments and their effect on GDP growth in EU

“…12 For an analysis on the impact of different proxies for the Balassa-Samuelson effect, based on relative productivities, in EU 28, see Comunale (2015a). In this paper two alternative measures are considered in estimating the REER determinants: productivity in industry as a proxy for productivity in manufacturing (value added in constant 2005 USD over number of employees) relative to the weighted average of partners and the productivity in industry over productivity in services relative to weighted average of partners.…”

Unconventional Monetary Policy: Interest Rates and Low Inflation. A Review of Literature and Methods

“…introducing an explicit role for global factors and co-movements (and spillovers/interactions), as stressed by Pedersen (2015) and Holston et al (2016); ii) adding demographics (Gagnon et al, 2016;Carvalho et al, 2016); 45 iii) allowing real effective exchange rate (REER) equilibria to be modelled by using real/financial determinants of REERs themselves (Lane and Milesi-Ferretti, 2004;Comunale, 2015; instead of having a REER equilibrium as a random walk, as in Berger and Kempa (2014) and Pedersen (2015); iv) recognizing a role for risk (Brand, 2016; properly modelling the euro area as a whole or a small open economy (Pedersen, 2015); and vi) having a framework that includes unconventional monetary policy actions (Pescatori and Turunen, 2015).…”