Interpreting real exchange rate movements in transition countries

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jinteco.2005.05.012 Byline: Mark De Broeck (a), Torsten SlA[cedilla]k (b) Keywords: Real exchange rates; Transition economies; Balassa-Samuelson effects Abstract: Real exchange rate movements in the transition economies during the initial transition period were unusually large by the standards of other economies and periods. Using cross-sectional evidence, this paper documents how real exchange rates were generally misaligned at the onset of the transition and how most of this misalignment was eliminated over a relatively short period. Turning to the time series dimension, the paper shows that estimates from a consensus-type single-equation model of the real exchange rate are well-behaved and provide a good fit for exchange rate movements in the early transition period. The results highlight the role of productivity-driven real exchange rate movements that can be interpreted as reflecting both the impact of the structural transformation process on productivity in the tradables sector per se and the effects of changes in tradables versus non-tradables productivity. Furthermore, the results show that the relationship between productivity and real exchange rates holds both when productivity is increasing and when it is falling. Author Affiliation: (a) Fiscal Affairs Department, International Monetary Fund, 700 19th Street, NW, Washington, DC 20431, USA (b) Deutsche Bank Foreign Exchange Research, 60 Wall Street, New York, NY 10005, USA Article History: Received 19 November 2001; Revised 1 September 2004; Accepted 20 May 2005