Shocks, Competitiveness, and Bilateral Real Exchange Rates in the Euro Area

Abstract

This paper analyses the structural drivers of bilateral real exchange rate dynamics within the euro area and between the euro area and the United States over 1999–2025, using an estimated seven-country New Keynesian DSGE model of the world economy. The model features an ex ante identical structure across the country blocs and is estimated on a unified information set. International financial market shocks dominate the EA–US bilateral real exchange rate dynamics, with productivity differentials generating persistent euro appreciation pressure. Rising world demand and a secular decline in EA home bias exert partially offsetting euro depreciation pressure. Within the monetary union, the pre-crisis appreciation of France, Italy, and Spain relative to Germany reflects country-specific combinations of demand, supply, and trade disturbances that broadly unwind after 2008. Trend productivity differentials emerge as the dominant low-frequency driver, most starkly for Italy, where persistently slower trend productivity growth drives the bilateral real exchange rate through the sample. Model validation against empirical moments, exchange rate pass-through benchmarks, and off-model indicators confirms the empirical plausibility of the structural identification.