Skip to main content

Real exchange rate misalignments in CEECs: Have they hindered growth?


We study the impact of exchange rate misalignment on economic activity in nine Central and Eastern European economies. Exchange rate misalignments are computed from country-specific long-run exchange rate relationships with determinants suggested by open macroeconomic models such as interest rate differentials or the Balassa–Samuelson effect. There was a clear reduction in misalignments, but this has been reversed to some extent after 2008. Exchange rate overvaluation has a negative impact on economic activity. The effect of misalignments on economic activity seems to be nonlinear, as overvaluation has a stronger effect than undervaluation. Other factors of economic activity, including institutions, also show nonlinear effects.

This is a preview of subscription content, access via your institution.

Fig. 1
Fig. 2
Fig. 3
Fig. 4
Fig. 5


  1. 1.

    Sweden has opted to stay out of the euro area by declining to join the ERM II.

  2. 2.

    For example, see Cuestas (2009) for a PPP study in CEE countries.

  3. 3.

    Some authors have moved to a framework with a very long span of data where there is some evidence that PPP may hold (e.g. Taylor 2002); however, this has also been challenged (e.g. Engel 2000).

  4. 4.

    As in Comunale (2017) an alternative approach is to include capital inflows. However, in our paper we include a larger numbers of fundamentals that may become collinear with capital inflows.

  5. 5.

    In short, the time series is viewed as the sum of transitory and permanent, or trend, components, where the filter captures the smooth path of the trend component by minimising the sum of the squares of its second difference. For each RER fundamental, the trend path is interpreted as the equilibrium level.

  6. 6.

    These variables have been transformed into quarterly observations.


  1. Aguirre A, Calderón C (2005) The real exchange rate misalignments and economic performance. Central Bank of Chile working paper no. 315

  2. Alberola E (2003) Misalignment, liabilities dollarization and exchange rate adjustment in Latin America. Bank of Spain, working paper no 309

  3. Arellano M, Bond SR (1991) Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. Rev Econ Stud 58:277–297

    Article  Google Scholar 

  4. Bajo-Rubio O, Díaz-Roldán C (2009) Does the balance of payments constrain economic growth? Some evidence for the new EU members. Post-Commun Econ 21(1):41–46

    Article  Google Scholar 

  5. Berg A, Miao Y (2010) The real exchange rate and growth revisited: The Washington consensus strikes back?. IMF working papers No. 10/58

  6. Colletaz G, Hurlin C (2006) Threshold effect in the public capital productivity: an international panel smooth transition approach. Document de Recherche du Laboratoire d’Economie d’Orléans 2006-01

  7. Comunale M (2017) Dutch disease, real effective exchange rate misalignments and their effect on GDP growth in EU. J Int Money Finance 73:350–370

    Article  Google Scholar 

  8. Cuestas JC (2009) Purchasing power parity in Central and Eastern European countries: an analysis of unit roots and nonlinearities. Appl Econ Lett 16:87–94

    Article  Google Scholar 

  9. Dollar D (1992) Outward-oriented developing economies really do grow more rapidly: evidence from 95 LDCs, 1976–85. Econ Dev Cult Change 40(3):523–544

    Article  Google Scholar 

  10. Égert B (2005) Balassa–Samuelson meets South Eastern Europe, the CIS and Turkey: a close encounter of the third kind? Eur J Comp Econ 2:221–243

    Google Scholar 

  11. Égert B, Drine I, Lommatzsch K, Rault C (2003) The Balassa–Samuelson effect in Central and Eastern Europe: Myth or reality? J Comp Econ 31:552–572

    Article  Google Scholar 

  12. Engel C (2000) Long-run PPP may not hold after all. J Int Econ 57:243–273

    Article  Google Scholar 

  13. Fok D, van Dijk D, Franses PH (2005) A multi-level panel STAR model for US manufacturing sectors. J Appl Econom 20(6):811–827

    Article  Google Scholar 

  14. Frankel J, Romer D (1999) Does trade cause growth. Am Econ Rev 89(3):379–399

    Article  Google Scholar 

  15. Frenkel JA, Razin A (1996) Fiscal policies and growth in the world economy, 3rd edn. The MIT Press, Cambridge

    Google Scholar 

  16. González A, Teräsvirta T, van Dijk D (2005) Panel smooth transition regression models. Quantitative finance research centre research paper 165

  17. Granger CWJ, Teräsvirta T (1993) Modelling nonlinear economic relationships. Oxford University Press, Oxford

    Google Scholar 

  18. Habib MM, Mileva E, Stracca L (2017) The real exchange rate and economic growth: revisiting the case using external instruments. J Int Money Finance 73:386–398

    Article  Google Scholar 

  19. Halpern L, Wyplosz C (2001) Economic transformation and real exchange rates in the 2000s: The Balassa–Samuelson connection. ECE discussion papers series 2001_1, UNECE

  20. Hansen B (1999) Threshold effects in non-dynamic panels: estimating, testing and inference. J Econom 93:345–368

    Article  Google Scholar 

  21. Jansen ES, Teräsvirta T (1996) Testing parameter constancy and super exogeneity in econometric equations. Oxf Bull Econ Stat 58:735–763

    Article  Google Scholar 

  22. Johansen S (1988) Statistical analysis of cointegrated vectors. J Econ Dyn Control 12:231–254

    Article  Google Scholar 

  23. Johansen S (1991) Estimation and hypothesis of cointegration vectors in gaussian vector autoregressive models. Econometrica 59:1551–1580

    Article  Google Scholar 

  24. Judson RA, Owen AL (1999) Estimating dynamic panel data models: a practical guide for macroeconomists. Econ Lett 65:9–15.

    Article  Google Scholar 

  25. Kadilli A, Markovz N (2012) A panel smooth transition regression model for the determinants of inflation expectations and credibility in the ECB and the recent financial crisis. Soc Sci Res Netw (SSRN) Electron J. Available at:

  26. Kaufmann D, Kraay A, Mastruzzi M (2008) Governance matters VII: aggregate and individual governance indicators, 1996–2007. World Bank policy research working paper 4654

  27. Levine R, Renelt D (1992) A sensitivity analysis of cross-country growth regressions. Am Econ Rev 82(4):942–963

    Google Scholar 

  28. MacDonald R, Vieira F (2010) A panel data investigation of real exchange rate misalignment and growth. CESifo working paper series 3061, CESifo Group Munich

  29. Mankiw NG, Romer D, Weil DN (1992) A contribution to the empirics of economic growth. Q J Econ 107:407–437

    Article  Google Scholar 

  30. Nickell SJ (1981) Biases in dynamic models with fixed effects. Econometrica 49:1417–1426

    Article  Google Scholar 

  31. Obstfeld M, Rogoff KS (1995) Exchange rate dynamics redux. J Polit Econ 103(3):624–660

    Article  Google Scholar 

  32. Prasad ES, Rajan RG, Subramanian A (2007) Foreign capital and economic growth. Brookings papers on economic activity, No. 27/1

  33. Razin O, Collins SM (1999) Real exchange rate misalignments and growth. In: Razin A, Sadka E (eds) The economics of globalization: policy perspectives from public economics. University Press, Cambridge, pp 59–81

    Chapter  Google Scholar 

  34. Rodriguez F, Rodrik D (1999) Trade policy and economic growth: a skeptic’s guide to the cross-national evidence. NBER working paper no. 7081

  35. Rodrik D (2008) The real exchange rate and economic growth. Brook Pap Econ Act 2:365–412

    Google Scholar 

  36. Sachs JD, Wagner A (1995) Economic reform and the process of global integration. Brook Pap Econ Act 1:1–118

    Article  Google Scholar 

  37. Sala-i-Martin X (1997) I just run a million regressions. Am Econ Rev 82:178–183

    Google Scholar 

  38. Schröder M (2013) Should developing countries undervalue their currencies? J Dev Econ 105:140–151

    Article  Google Scholar 

  39. Seleteng M, Bittencour M, van Eyden R (2013) Non-linearities in inflation-growth nexus in the SADC region: a panel smooth transition regression approach. Econ Model 30(1):149–156

    Article  Google Scholar 

  40. Taylor A (2002) A century of PPP. Rev Econ Stat 84:139–150

    Article  Google Scholar 

  41. Teräsvirta T (1994) Specification, estimation, and evaluation of smooth transition autoregressive models. J Am Stat Assoc 89:208–218

    Google Scholar 

  42. Thirlwall AP (1979) The balance of payments constraint as an explanation of international growth rate differences. Banca Nazionale del Lavoro Quarterly Review 128:45–53

    Google Scholar 

  43. Thirlwall AP, Hussain MN (1982) The balance of payments constraint, capital flows and growth rate differences between developing countries. Oxf Econ Pap 34:498–510

    Article  Google Scholar 

Download references


Juan Carlos Cuestas acknowledges the financial support from the ECO2017-85503-R and ECO2017-83255-C3-3-P Projects from `Agencia Estatal de Investigación’ (AEI) Spain and `Fondo Europeo de Desarrollo Regional’ (FEDER). Comments from two anonymous referees are gratefully acknowledged. The views expressed are those of the author and do not necessarily represent the official views of Eesti Pank, the European Central Bank or the Eurosystem.

Author information



Corresponding author

Correspondence to Paulo José Regis.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Data appendix

Data appendix

The first set of variables is the real exchange rate and six other variables that represent its fundamentals: per capita output, openness, terms of trade, investment, government spending, and interest rate differentials against Germany. All of them are transformed into logs, except interest rate differentials. Figures for GDP and GDP-related components (government consumption, gross capital formation and exports plus imports) and for population come from Eurostat, as does terms of trade, which is defined as the ratio of price indexes for exports and imports, and the real effective exchange rate. To obtain real interest rates, the harmonised CPI series were taken mainly from Eurostat. The harmonised CPI time series from Eurostat for the period 1996Q1-2012Q4 has been expanded backward using national CPI figures from the IMF statistics. To compute real interest rates, forward looking rational expectations are assumed implicitly since the nominal interest rates, which are annualised, are adjusted by the year to year change in the CPI one period ahead.

The time series for interest rates were mainly taken from the IMF IFS database for deposit rates. It was challenging to obtain comparable interest rates for the full period 1995Q1-2012Q4 for some countries because of changes in the methodology. Countries which join the euro area are required to homogenise their statistics for retail market interest rates within a set timeframe. Euro area members collect their interest rate statistics following the standards of the Monetary Financial Institutions (MFI) statistics. Once a country joins the MFI statistics, it is difficult to compare the new time series with those that came earlier. Germany, our choice for the representative international interest rate for these economies, is the country where this limitation is most severe, as the methodology there changed in 2003. The countries in the sample that changed their methodology are Poland (2006), Slovakia (2008), Slovenia (2009) and Lithuania (2010), while Bulgaria, the Czech Republic, Estonia, Hungary and Latvia used the same methodology throughout the whole period 1994-2012. For the countries where the methodology was changed, the national interest rates (\(i_{N}\)) for the initial part of the sample were complemented, when necessary, with the new IMF series (\(i_{IMF}\)) to extend the series out to 2012Q4. If there is a change in the methodology in the period, the old series is extrapolated with the new series: \(i_{Nt + 1} = i_{Nt} (i_{IMF t + 1} /i_{IMF t} )\).

Additional annual variables that were considered, having been transformed into quarterly observations, include school enrolment (secondary school,  % gross), domestic credit provided by the financial sector (% of GDP), and money and quasi money (M2, as  % of GDP), which were taken from the World Development Indicators (World Bank). Data for the institutional variables of control of corruption, rule of law and regulatory quality come from the World Bank governance dataset (Kaufmann et al., 2008).

Rights and permissions

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Cuestas, J.C., Mourelle, E. & Regis, P.J. Real exchange rate misalignments in CEECs: Have they hindered growth?. Empirica 47, 733–756 (2020).

Download citation


  • Real exchange rate misalignments
  • Growth
  • Central and Eastern European countries
  • Panel smooth transition regression

JEL Classification

  • O11
  • F41
  • F15