Real Exchange Rate Dynamics in Transition Economies

The paper analyzes the phenomenon of real exchange rate appreciation that has characterized transition economies. It is shown that the real exchange rate-measured as the relative price of tradables in terms of non-tradables-is affected by adverse initial conditions and structural reforms only in the first 5 years of the transition process. After that period, the so-called Balassa-Samuelson effect seems to dominate the real exchange rate determination. The paper discusses the implications for exchange rate policy and concludes that while for countries of the former Soviet Union a flexible exchange rate regime seems desirable, for Central and Eastern Europe countries a stable exchange rate and even an early move to the adoption of the euro should be considered. © 2003 Elsevier B.V. All rights reserved.