Real exchange rate determination in eastern Europe

This paper develops a simple theoretical model of exchange rate determination in a transitional economy. The distinguishing feature of the model is the retention of market failures pertaining to the production and consumption of nontradable goods and, therefore, the likelihood of real exchange rate appreciation. Using this framework, the econometric tests are performed for the Czech Republic, Slovenia, Poland, and Hungary, and appropriate macroeconomic and exchange rate policies are recommended to support further liberalization and development of the foreign exchange market.