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

This paper employs advanced model selection methods to identify the most robust fundamental factors driving real effective exchange rates in a large sample of 76 countries.

Highlights

• Authors use variable selection methods to identify robust fundamental drivers of real effective exchange rates.
• The Balassa-Samuelson effect, several demographic variables, capital and trade openness prove important across country subsamples, weighting schemes, and model specifications.
• We find that real exchange rate misalignments correct slowly, transition economies exhibit faster adjustment rates. 
• Trade-in-value-added weights along with gross-trade weights prove insightful during episodes of global supply chain disruption, such as the COVID-19 pandemic.

Information and identifiers

Discussion Paper 254. July 2026. Brussels. PDF. 64pp. Tab. Graph. Bibliogr. Free.

KC-01-26-054-EN-N (online)
ISBN 978-92-68-40202-3 (online)  
ISSN 2443-8022 (online)
doi:10.2765/6708041 (online) 

JEL classification: C33, F31, F41, F37.

Disclaimer

European Economy Discussion Papers are written by the staff of the European Commission’s Directorate-General for Economic and Financial Affairs, or by experts working in association with them, to inform discussion on economic policy and to stimulate debate. The views expressed in this paper are solely those of the author(s) and should not be considered as representative of the European Commission, the OeNB and the Banque de France or Eurosystem’s official position.