A Well-Crafted BEER: Identifying the Fundamental Drivers of Real Exchange Rates

Mirjam Salish, Mathilde Dufouleur, Milan Výškrabka and Stefan Zeugner

No 254, European Economy - Discussion Papers from Directorate General Economic and Financial Affairs (DG ECFIN), European Commission

Abstract: This paper presents new empirical evidence on the determinants of real effective exchange rates (REERs) using a novel comprehensive dataset of 76 countries from 1995 to 2022, with a focus on level REERs. In addition to gross trade weights, we incorporate trade in value-added weights to account for global value chains’ impact on exchange rates and macroeconomic imbalances. Using advanced model selection techniques, we identify key fundamental factors driving REERs and show that the resulting model outperforms alternatives in terms of robustness without having to sacrifice in-sample fit or out-of-sample predictive accuracy. We exploit level REERs to analyse price level convergence. REER misalignments narrow slowly over time, with converging economies showing faster adjustment rates. Applications of the model allow us to analyse the impact of fundamentals, such as demographic change, on convergence, as well as to study exchange rate misalignments at the global level, offering a complementary, price-based perspective on global imbalances.

JEL-codes: C33 F31 F37 F41 (search for similar items in EconPapers)
Pages: 64 pages
Date: 2026-07
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Persistent link: https://EconPapers.repec.org/RePEc:euf:dispap:254

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