The estimation of the equilibrium real exchange rate for Romania

Abstract

This paper aims to estimate the equilibrium real exchange rate for Romania, respectively the real exchange rate consistent with the macroeconomic balance, which is achieved when the economy is operating at full employment and low inflation (internal balance) and has a current account that is sustainable (external balance). This equilibrium real exchange rate is very important for an economy because deviations of the real exchange rate from its equilibrium value can affect the competitiveness of a country. An overvalued real exchange rate will determine a lack of external competitiveness and deteriorate the country’s real activity. An undervalued exchange rate will increase on short term exports and it will lower the current account deficit but, on the long term it will increase the inflationary pressures. The equilibrium real exchange rate is also a very important variable for a country who wishes to join ERM II. In fact the central parity should be chosen to reflect the equilibrium exchange rate. The conclusion is that the real exchange rate had some important deviations from its equilibrium value which were determined by the liberalization of the prices and of the foreign exchange market and by the fluctuations of the nominal exchange rate. These deviations are not likely to put at risk the entry in ERM II.