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Working Paper Summaries (WP/94/1 - WP/94/76)
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Working Paper Summaries 94/19: Real Exchange Rates and the Prices of Nontradable Goods

Author(s):
International Monetary Fund
Published Date:
August 1994
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Until September 1992, the European Monetary System (EMS) was characterized by an appreciation of the real effective exchange rate in higher inflation countries, such as Italy and Spain. EMS members have also experienced very different dynamics in the relative price of tradable goods in terms of nontradables, and in relative sectoral productivity.

This paper tries to provide a perspective on real exchange rate developments after the inception of the EMS. It focuses on structural determinants of real exchange rates, notably prices of tradables and nontradables, and productivity. The analysis shows that changes in the relative price of tradable goods in terms of nontradables account for a sizable fraction of real effective exchange rate dynamics until September 1992 in both Italy and Spain.

In accordance with theory, the study shows that sectoral productivity growth differentials help explain the behavior of the relative price of tradable goods, especially in the long run. There is also some evidence that the EMS had an impact on relative price behavior.

Finally, productivity developments may also explain the divergent behavior of real exchange rate indicators, such as those based on relative value-added deflators and relative unit labor costs.

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