Real Effective Exchange Rate Misalignment in the Euro Area: A Counterfactual Analysis


The European debt crisis has revealed severe imbalances within the Euro area, sparking a debate about the magnitude of those imbalances, in particular concerning real effective exchange rate misalignments. We use synthetic matching to construct a counterfactual economy for each member state in order to identify the degree of these misalignments. We find that crisis countries are best described as a combination of advanced and emerging economies. Comparing the actual real effective exchange rate with those of the counterfactuals gives evidence of misalignments before the outbreak of the crisis - all peripheral countries appear strongly and significantly overvalued.

Review of International Economics, 24(1), 37-66