Eurozone's equilibrium real exchange rates: Is there a difference between north and south

Objective:  The objective of this paper is to analyze the long term dynamics of the real exchange rates in the Eurozone with the emphasis on the “North” and “South” differences  and to estimate the relevant “equilibrium” values. It is today increasingly recognized that the diverging real exchange rates (i.e. the diverging competitiveness) between the Eurozone members are at the root of the current crisis. But the equilibrium real exchange rate dynamics during the common currency existence is seldom analyzed and compared, especially as far as the different groups of countries (and/or different areas within the Eurozone) are concerned. This paper aims to contribute to filling this gap.

Background: It is important for the success of a monetary union to analyze the longer term trends. This is especially so in the organization like EMU (Eurozone), where the monetary centralization operates in the environment of decentralized fiscal structures, limited fiscal transfers between the participating entities (independent states) and very limited labor mobility.

In such an environment, the diverging trends between the participating entities (states) are unlikely to be compensated for by an induced factor movements and/or structural changes (not to mention fiscal transfers etc.), as happens in the similar dynamics within the centralized political entities (individual states).

Method and Data: This paper endeavors to investigate the dynamics of the real exchange rates in the EMU. The BEER (behavioral equilibrium exchange rate) models are used to estimate the equilibrium real exchange rates for the Northern (core) and the Southern (periphery) countries. Subsequently, the results are used to study the competitiveness stability of the Eurozone. Data for the study are obtained from both the Eurostat and the ECB. 

Expected Results:  We expect to find that in the first 13 years of its existence the significant and rising divergences developed in the area most important for the long run economic performances of the Eurozone as a whole. That conclusion is expected to hold for both the actual dynamics and the estimated equilibrium one.  As recent developments demonstrated, unless addressed, this divergence trend may constitute a significant, and perhaps the ultimate, threat to the Eurozone cohesion and perhaps to its existence.