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Real exchange rate adjustments around the globe

Real effective exchange rate adjustment trends in the aftermath of the global financial and economic crisis were generally not out of line with histor

Publishing date
12 December 2012
Zsolt Darvas

Real effective exchange rate adjustment trends in the aftermath of the global financial and economic crisis were generally not out of line with historical developments, and were in the right direction for a number of major currencies, though with major exceptions. The largely asymmetric impact of the crisis on advanced and emerging countries and their different outlooks call for an exchange rate adjustment between the two groups. Yet neither of the two groups is homogeneous and, in particular, a weakened euro exchange rate toward all trading partners would help to overcome the euro crisis.

The real effective exchange rate (REER), which measures the development of the real value of a country’s currency against the basket of the trading partners of the country, is an important indicator for assessing the change in price or cost competitiveness of a country. Changes in the REER can influence trade flows and provide incentives for the reallocation of production between the tradable and the non-tradable sectors. Various relative price and cost measures are used to adjust the nominal change in the exchange rate (as discussed eg in Chinn, 2006), of which the consumer price index (CPI) is the most frequently used, because of to its relative availability and cross-country comparability.



Source: The November 2012 update of the database of Darvas (2012a), which includes annual CPI-based REERs for 178 countries (plus the euro area) and monthly REERs for 153 countries (plus the euro area), using a consistent methodology. Note: the REERs are calculated against the basket of 138 trading partners. The vertical line indicates December 2007.

Figure 1 shows the developments of monthly CPI-based REERs for various countries around the globe between 1995 and 2012: five advanced economies (top-left panel), the BRICS (top-right panel), five Asian countries that experienced massive exchange rate depreciation during the 1997-98 Asian crises (bottom-left panel) and five larger emerging and developing countries from Europe and Africa (bottom-right panel).

A first visual impression from the panels is that movements since 2007 have not been out of the ordinary relative to the developments of the preceding decade. The rapid rise of the Swiss franc is a clear exception, since the Swiss REER increased by almost 40 percent from December 2007 to August 2011. In August 2011, the Swiss National Bank introduced an upper ceiling to the franc/euro exchange rate in order to reverse the appreciation trend.

Switzerland received a huge inflow of capital related to the uncertainties of the euro-crisis, and thereby the franc has been considered a ‘safe-haven currency’. The rapid rise of the Japanese yen may also ben explained by safe-haven motivations, yet in late 2007 the yen had a very weak exchange rate and even after the appreciation, which followed the collapse of Lehman Brothers in September 2008, the Japanese REER remained below the average of the preceding decade.

Interestingly, two other safe-haven currencies, the US dollar and the UK pound sterling, did not appreciate much, even though the record low levels of their government bond yields would suggests that their demand has increased. The dollar appreciated somewhat after the Lehman shock, but has fallen subsequently, possibly due to the monetary policy of the Federal Reserve (three rounds of quantitative easing plus zero interest rate policy which is declared to last for a number of additional years). In cumulative terms the dollar’s REER is almost at the same level where it was in late 2007. And sterling has even depreciated sharply and is still about 10 percent weaker than in late 2007.

The currencies of those emerging countries that have floating exchange rates typically depreciated after the Lehman shock, but in most cases this proved to be temporary. Brazil, for example, had a rather strong exchange rate before the Lehman’s collapse and faced a sharp but only temporary depreciation, and its REER increased to historical highs by the summer of 2011. Korea, on the other hand, is an interesting exception. Among the five Asian countries suffering from massive exchange rate deprecations in 1997-98, Korea was the only one in which the REER depreciated significantly after the Lehman shock, with the deprecation proving rather persistent. Other exceptions are the Polish zloty and the new Turkish lira, which also remained at a lower value than in late 2007, though both currencies appreciated very significantly before the crisis.

Turning to countries with limited exchange rate flexibility, such as China and Saudi Arabia, the developments of their exchange rates were largely determined by the movements of the US dollar. Following a long period of nominal fixity to the dollar at a rate of 8.3, the Chinese renminbi appreciated to about 6.85 from mid-2005 to mid-2008, when it was fixed again at this rate till mid-2010. Then the renminbi was again allowed to appreciate against the dollar to a rate of 6.25 in November 2012. Since the dollar was depreciating from about 2001, so did the renminbi till 2005 and it also followed the dollar’s rise and fall after Lehman’s collapse till mid-2010, when the renewed nominal appreciation and the somewhat higher inflation started to push up the real rate. In real effective terms the cumulative appreciation of the renminbi was close to 20 percent from December 2007 to November 2012. Along with domestic reforms including a gradual opening of the capital account*, the real exchange rate appreciation may have helped to reduce the current account surplus of China and led to a deceleration in the pace of reserve accumulation. These developments were the major reasons why the recent report of the US Department of Treasury (2012) does not name China as a currency manipulator. Saudi Arabia, on the other hand, keeps a tight peg to the dollar and continues to possess very large current account surpluses, which are supported by high oil prices.

Are these REER developments in line with economic principles?

There is a fundamental asymmetry between advanced and emerging countries concerning the short-term impact of the global crisis and also their medium-term outlooks (Darvas and Pisani-Ferry, 2010). In most advanced countries private sector deleveraging coupled with banking problems and fiscal consolidations set demand subdued for years to come. The output loss during the crisis proved to be permanent. In contrast, emerging countries were barely hit by the crisis with the main expectation of central and eastern European emerging countries. This fundamental asymmetry needs to be compensated by some adjustment in real exchange rates, even though the exports from the block of advanced countries to the block of emerging countries are not that high. Following the turbulent period immediately after the Lehman shock, some adjustment has started in this direction, but probably it is fair to claim that more is needed.

Yet neither the emerging, nor the advanced countries constitute homogenous blocks. Emerging countries that have open capital accounts and floating exchange rates are more exposed to volatile capital inflows than those that impose capital controls and manage their currencies tightly.

Within the group of advanced countries, the euro area has arguably the most vulnerable situation and the weakest outlook due to the triple crises of balance of payments, banking and sovereign of some of its members. A weaker euro would help a lot to stabilise the situation. The euro’s external REER has weakened about 13 percent since December 2007 and is now close to the historical average of the last one and a half decades (Figure 1), yet a further sizeable depreciation would be essential (Darvas, 2012b). It would help the extra-euro export of the troubled southern euro-members, but would help Germany and other stronger countries even more due to their larger tradable sectors. That in turn would boost inflation and wage increases in Germany, thereby helping the intra-euro adjustment of the real exchange rates and lessening the need for price and wage deflation in southern Europe. It is difficult to achieve deflation, but a deflation would also worsen both private and public debt sustainability. In order to achieve a weaker euro, the European Central Bank should only to what other major central banks, such as the Federal Reserve, the Bank of England and the Bank of Japan have done: a more accommodative monetary policy stance by a sizeable quantitative easing and more interest rate cuts accompanied by a commitment to keep the rates low for a longer period.


Angeloni, Ignazio, Agnès Bénassy-Quéré, Benjamin Carton, Christophe Destais, Zsolt Darvas, Jean Pisani-Ferry, André Sapir and Shahin Vallée (2011) ‘Global currencies for tomorrow: a European perspective’, Bruegel Blueprint 13

Chinn, Menzie D. (2006) ‘A Primer on Real Effective Exchange Rates: Determinants, Overvaluation, Trade Flows and Competitive Devaluation’, Open Economies Review 17, 115–143

Darvas, Zsolt (2012a) ‘Real effective exchange rates for 178 countries: A new database’, Working Paper 2012/06, Bruegel

Darvas, Zsolt (2012b) ‘Intra-euro rebalancing is inevitable, but insufficient’, Policy Contribution 2012/15, Bruegel

Darvas, Zsolt and Jean Pisani-Ferry (2010) ‘The Threat of Currency Wars: A European Perspective’, Policy Contribution 2010/12, Bruegel

U.S. Department of Treasury (2012) Report to Congress on International Economic and Exchange Rate Policies, 27 November

About the authors

  • Zsolt Darvas

    Zsolt Darvas is a Senior Fellow at Bruegel and part-time Senior Research Fellow at the Corvinus University of Budapest. He joined Bruegel in 2008 as a Visiting Fellow, and became a Research Fellow in 2009 and a Senior Fellow in 2013.

    From 2005 to 2008, he was the Research Advisor of the Argenta Financial Research Group in Budapest. Before that, he worked at the research unit of the Central Bank of Hungary (1994-2005) where he served as Deputy Head.

    Zsolt holds a Ph.D. in Economics from Corvinus University of Budapest where he teaches courses in Econometrics but also at other institutions since 1994. His research interests include macroeconomics, international economics, central banking and time series analysis.

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