Comparing alternative methodologies for real exchange rate assessment

Abstract

This paper compares alternative methodologies for estimating real exchange rate misalignment for EU countries. It is shown that current account-based approaches (based on NFA stabilisation and current account norms) and relative-price based approaches (BEER and PPP-based) deliver broadly consistent assessments, however sometimes differences are non-negligible. Moreover, the behaviour of the two relative price-based approaches does not appear to be as fully aligned as expected. Current account-based misalignment appears to be driven to a larger extent by shocks affecting domestic absorption and national savings and quite often becomes manifest before price-based misalignment. All misalignment measures, and especially the BEER, are significantly related with medium-term developments in real exchange rates (overvaluation implying a forthcoming reduction in the REER), while only current-account based misalignment is a significant predictor of forthcoming current account developments.

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