Abstract

Perhaps the element that is most commonly taken into account in attempting to assess whether a country’s exchange rate is at an appropriate level is its price competitiveness. Such an assessment normally takes the form of a straightforward comparison of past movements in prices at home and abroad, after adjustment for exchange rate changes. If the comparison indicates that the country considered has experienced significant losses or gains in its price competitiveness in relation to a base period when its position was considered adequate, this finding is viewed as establishing a presumption that the current exchange rate is unsustainable.8 Sustainability can, of course, be restored through a change in the nominal exchange rate, a change in the level of domestic currency prices relative to those abroad, or some combination of the two. In many cases, a comparison of movements in production costs is made as a supplement, or an alternative, to a comparison of movements in prices. Indicators of relative prices or costs adjusted for exchange rate changes are here referred to as “real exchange rates.”