Estimation of the Behavioral Equilibrium Real Exchange Rate of the Czech Koruna

Abstract

Purpose of the article: The paper examines the behavior of the real exchange rate in the Czech Republic. It focuses on the analysis of its driving forces with the emphasis on the turbulences which have been lately seen in the financial and real sector of the economy. Methodology/methods: Real equilibrium exchange rate can be estimated using various approaches ranging from purely statistical to fully structural models. In this paper it is estimated using the BEER methodology, i.e. behavioral equilibrium exchange rate. The BEER approach as applied here rests on building vector error correction models which relate the behavior of the actual real exchange rate to various economic fundamentals from both the real and financial sector of the economy. Scientific aim: The estimated behavioral equilibrium exchange rate serves as a benchmark to which the actual behavior of real exchange rate is compared. The paper also points to various problems that are faced when estimating the real equilibrium exchange rate in a posttransitive economy. Findings: Three variants of the model, which differ in the respective fundamental variables inluded in the estimation, are estimated in the paper. The gap between the estimated real equilibrium exchange rate and real exchange rate as well as the key determinants of the real equilibrium exchange rate are analyzed and compared. The models show that the misalignment between the real exchange rate and fundamentals have narrowed in the recession and post recession period. The key drivers of the real equilibrium exchange rate are the productivity differential, real interest rate differential and net foreign assets. Conclusions: (limits, implications etc) The relatively short time series for the Czech economy, especially for some of the variables, do not enable to make reliable estimation of models which would include all of the variables discussed in this paper. This paper is a part of a research project financed by IGA University of Economics, Prague