Real Exchange Rate Misalignments in the Euro Area

Insulating property of the flexible exchange rate regime: A case of Central and Eastern European countries

“…As far as policy implications are concerned a word of caution seems to be in place, especially as all CEE countries examined are formally obliged to join the euro area and Slovakia and Slovenia have already adopted the common currency. Our empirical results weigh in favour of the flexible exchange rate regime as it provides a partial insulation against shocks (see, e.g., Obstfeld et al, Another argument is on currency misalignments in real terms: Fidora et al (2018) found that the euro area countries recorded smaller misalignment, albeit it was more persistent than in countries outside the euro area 'owing to the absence of a nominal adjustment channel.' Yet another argument is on transaction costs: Chen and Novy (2018), for example, found that currency unions lower trade costs and promote trade, although there is 'a significant amount of heterogeneity across country pairs' and the average trade effect of the euro is modest.…”

Equilibrium Real Exchange Rate Estimates Across Time and Space

“…The description of the two strategies for determining an equilibrium real exchange rate and a currency misalignment in the previous section has been cast in the context of an FE estimation. Couharde et al (2017), Fidora et al (2017), and Phillips et al (2013) are recent examples from the literature where such an estimation method has been chosen. Given the definition of an equilibrium exchange rate above, however, the misalignments could, in principle, have been calculated using alternative conventional panel estimation methods (cf .…”

“…Variables which are not percentage shares are expressed in logs (as, for instance, in Fidora et al, 2017). These are the relative price levels, per capita GDP and the terms of trade.…”

“…The relevant studies differ, however, in the panel estimation technique applied. To give some examples, Couharde et al (2017) and Fidora et al (2017) use fixed effects estimators, Fischer and Hossfeld (2014) present fixed effects and pooled OLS estimates, Cheung et al (2007) and Berka et al (2018) compute fixed effects, between effects, random effects and pooled OLS estimates and, in their external balance assessment (EBA) framework, the IMF provides both, a fixed effects-based regression (cf. Phillips et al, 2013) and a 2SLS regression (cf.…”

“…The term "correlated random effects model" is used, for instance, inWooldridge (2010), p. 286, or in Cameron andTrivedi (2005), p. 786. Note that the correlated random effects model considered here and the common correlated effects models used, for instance, byBussière et al (2010) andFidora et al (2017) for the calculation of exchange rate misalignments are quite different concepts. The common correlated effects models augment the explanatory variables by cross section averages in order to address the issue of cross-sectional dependency.…”