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1 Occsionl Pper series No 134 / JUNE 2012 REVISITING THE EFFECTIVE EXCHANGE RATES OF THE EURO by Mrtin Schmitz, Mrten De Clercq, Michel Fidor, Berndette Luro nd Cristin Pinheiro

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3 OCCASIONAL PAPER SERIES NO 134 / JuNE 2012 REVISITING THE EFFECTIVE EXCHANGE RATES OF THE EuRO In 2012 ll publictions feture motif tken from the 50 bnknote. by Mrtin Schmitz, Mrten De Clercq, Michel Fidor, Berndette Luro nd Cristin Pinheiro 1 NOTE: This Occsionl Pper should not be reported s representing the views of the Europen Centrl Bnk (). The views expressed re those of the uthors nd do not necessrily reflect those of the. This pper cn be downloded without chrge from or from the Socil Science Reserch Network electronic librry t 1 The uthors would like to thnk F. Gross, P. Krdeloglou, H.-J. Klöckers, S. Mkrydkis, L. Nordquist, R. Oliveir-Sores, A. vn Riet, A. Schubert nd C. Willeke for their comments. Any errors or omissions re exclusively the responsibility of the uthors.

4 Europen Centrl Bnk, 2012 Address Kiserstrsse Frnkfurt m Min, Germny Postl ddress Postfch Frnkfurt m Min, Germny Telephone Internet Fx All rights reserved. Any reproduction, publiction nd reprint in the form of different publiction, whether printed or produced electroniclly, in whole or in prt, is permitted only with the explicit written uthoristion of the or the uthors. Informtion on ll of the ppers published in the Occsionl Pper Series cn be found on the s website, scientific/ops/dte/html/index.en.html. Unless otherwise indicted, hrd copies cn be obtined or subscribed to free of chrge, stock permitting, by contcting [email protected] ISSN (print) ISSN (online)

5 CONTENTS ABSTRACT 4 CONTENTS NON-TECHNICAL SuMMARY 5 1 INTRODuCTION 7 2 METHODOLOGY FOR CALCuLATING THE EFFECTIVE EXCHANGE RATES OF THE EuRO Trde bsis Trding prtners Clculting the nominl effective exchnge rtes of the euro The rel effective exchnge rte nd its defltors Bse period nd frequency Aggregtion of Pre-1999 legcy currency dt to proxy the euro exchnge rte Adjustments in the effective exchnge rtes of the euro due to euro re enlrgements EFFECTIVE EXCHANGE RATES OF THE EuRO AND HARMONISED COMPETITIVENESS INDICATORS OVER TIME Nominl effective exchnge rtes of the euro Rel effective exchnge rtes of the euro Hrmonised competitiveness indictors of euro re countries CONCLuSION 3 1 REFERENCES 3 2 APPENDIX 3 4 3

6 ABSTRACT This pper describes in detil the methodology currently used by the Europen Centrl Bnk () to determine the nominl nd rel effective exchnge rte indices of the euro. Building on the work of Buldorini et l. (2002), it shows how the s techniques for clculting effective exchnge rtes hve been updted over time nd explins the relted theoreticl foundtions. In prticulr, the pper discusses the use nd development of trde weights bsed on trde in mnufctured goods (tking ccount of third mrket effects), the trding prtners selected, nd the choice of defltors for constructing the rel effective exchnge rte indices. In ddition, it presents evidence on exchnge rte nd competitiveness developments for both the euro re s whole nd individul Member Sttes. While the growing importnce of Chin is reflected in the updted trde weights of euro effective exchnge rtes, it ppers tht the incresing integrtion of the euro re with other Europen economies ccounts for the lrgest vrition in trde weights. The US dollr, n nchor currency for number of lrge emerging mrkets, continues to ply n importnt role for the effective exchnge rte of the euro nd euro re competitiveness. Overll, euro re competitiveness hs improved slightly since the introduction of the single currency, despite significnt heterogeneity within the euro re. JEL codes: F10, F30, F31, F40 Keywords: competitiveness, effective exchnge rte (EER), hrmonised competitiveness indictor (HCI), nominl effective exchnge rte (NEER), rel effective exchnge rte (REER), trde weights 4

7 NON-TECHNICAL SuMMARY In preprtion for the strt of Stge Three of the Economic nd Monetry Union (EMU), the Europen Centrl Bnk nd the ntionl centrl bnks (NCBs) of prticipting countries begn work on the construction of set of effective exchnge rte (EER) indictors for the euro bsed on commonly greed methodologicl frmework. The generl methodologicl principles of the euro EER indices were greed upon in Februry 1999, with the implementtion of this commonly greed frmework being undertken by the. The Eurosystem s pproch to clculting the EERs of the euro is described by Buldorini et l. (2002) nd brodly follows the methodology of the Bnk for Interntionl Settlements (BIS). The weights ssigned to trding prtners re derived from their shre in interntionl trde in mnufctured goods, nd combine informtion on both exports nd imports. The import weights re the simple shres of ech prtner country in totl euro re imports. As for the export weights, these re determined in such wy tht they cpture both the importnce of specific euro re export mrkets nd the competition fced by euro re exporters in foreign mrkets from domestic producers nd exporters from third countries. The nominl EERs of the euro re geometric weighted verges of the bilterl exchnge rtes of the euro ginst the currencies of the euro re s min trding prtners. Hence, they provide summry mesure of the euro s vlue vis-à-vis these currencies. The rel EERs of the euro obtined by deflting the nominl EERs by different price or cost indices re commonly used indictors of interntionl price nd cost competitiveness. Depending on dt vilbility, rel EERs re clculted on monthly or qurterly bsis. Historicl dt required for the compiltion of the indices for the yers before 1999 re computed using theoreticl euro exchnge rtes: clculted on the bsis of the exchnge rtes of the legcy currencies of individul euro re countries. Since 1999, number of enhncements hve been introduced to the methodology for clculting the EERs. When the trde weights were updted for the first time in 2004, the list of countries included in the lrgest group of trding prtners ws expnded to encompss ll Europen Union (EU) Member Sttes nd ccession countries. In ddition, new group of trding prtners ws creted, composed of the 12 countries lredy in the nrrow group of trding prtners plus the ten tht joined the EU in 2004 nd Chin (given its emergence s one of the euro re s lrgest trding prtners). Production of EERs bsed on the nrrow group ws not discontinued, s these time series strt erlier thn those bsed on the lrger groups. This is due to the fct tht, for certin countries, dt for erlier periods re not vilble. In 2006, methodologicl simplifiction ws introduced, whereby the trde weights for the smller groups of trding prtners re obtined by proportionlly rescling the weights of the lrgest group of trding prtners. The trde weights re now revised nd updted every three yers. The second nd third revisions took plce in December 2009 nd Jnury 2012, respectively. Following n updte, the EERs nd hrmonised competitiveness indictors (HCIs) re reclculted by chin-linking the indices bsed on the trde weights for consecutive three-yer periods (currently , , , nd ). The trde weights re lso reclculted following ech enlrgement of the euro re. In 2006, the strted publishing HCIs deflted by consumer prices for ech individul euro re country. Since 2008, the hs lso published HCIs bsed on gross domestic product (GDP) defltors nd unit lbour costs for the totl economy. The HCIs provide meningful nd comprble mesures of the price nd cost competitiveness of euro re countries tht re consistent with the rel effective exchnge rtes of the euro. The HCIs re in fct constructed using the sme methodology s tht for the rel euro EERs. NON-TECHNICAL SuMMARY 5

8 The min objective of this pper is to provide comprehensive ccount of the methodologicl frmework dopted by the Eurosystem to clculte its set of effective exchnge rtes nd hrmonised competitiveness indictors. 1 Accordingly, the pper contins previously unpublished technicl informtion on the construction of nominl nd rel euro EERs s well s the HCIs for euro re countries. It lrgely builds on the work of Buldorini et l. (2002) nd highlights the modifictions in methodology tht hve been introduced over the lst decde. The pper lso presents evidence on developments in the effective exchnge rtes of the euro nd the competitiveness of the euro re s whole s well s of individul Member Sttes. In ddition, while the growing importnce of Chin is reflected in the updted trde weights of euro EERs, it ppers tht the incresing integrtion of the euro re with other Europen economies ccounts for the lrgest vrition in trde weights. The United Sttes (US) dollr, which serves s n nchor currency for number of lrge emerging mrkets, continues to ply n importnt role for the effective exchnge rtes of the euro nd euro re competitiveness. Overll, since the introduction of the single currency, the competitiveness of the euro re hs improved slightly reltive to its min trding prtners, but there remins significnt degree of heterogeneity cross euro re countries. The HCIs re therefore useful complement to the EERs in the nlysis of euro re competitiveness. 1 The effective exchnge rtes of the euro nd the HCIs for euro re countries cn be obtined from the s Sttisticl Dt Wrehouse ( Up-to-dte informtion is lso vilble vi the following links: en.html nd en.html. 6

9 1 INTRODuCTION In times of globl economic integrtion, countries re incresingly influenced by movements in their exchnge rtes vis-à-vis the currencies of mny prtner countries. This is prticulrly true for the euro re, with this being the most open of the world s lrgest economies. 2 In order to obtin useful ggregte mesure of exchnge rte fluctutions, n effective exchnge rte combines vrious bilterl rtes into single indictor. There re two distinct indictors to mesure these fluctutions: the nominl effective exchnge rte (NEER) nd the rel effective exchnge rte (REER). While the euro NEER is the weighted verge of bilterl nominl exchnge rtes ginst the currencies of selected trding prtners, the REER indices re derived by djusting the nominl indices for reltive price nd cost developments between given economy nd its trding prtners. To construct these indices in meningful wy, one needs to decide on the composition of the index nd the reltive weights of the vrious prtner currencies. The weighting method for euro EERs reflects the importnce of different countries in euro re trde in mnufctured goods, hence ccounting for trde integrtion with these countries. The trde weights combine informtion on both exports nd imports. While import weights re ech trding prtner s simple shre of totl euro re imports, export weights re double-weighted to ccount for third mrket effects. Specificlly, they cpture the effect of competition fced by euro re exporters in foreign mrkets from both domestic producers nd exporters from third countries. The NEER of the euro is summry mesure of the euro s vlue vis-à-vis the currencies of the euro re s most importnt trding prtners. Menwhile, the REER usully serves s mesure of interntionl price nd cost competitiveness: it cptures brod mcroeconomic developments in the exchnge rte nd prices or costs. While it neither includes ny firm-level dt nor explicitly revels fctors relting to non-price competitiveness (such s product qulity nd reputtion), it does, nevertheless, provide comprehensive ssessment of the interntionl pressures on domestic firms over the medium term in respect of costs or prices. The high relevnce of the rel effective exchnge rte s mesure of competitiveness is lso reflected by its inclusion in the scorebord of the EU Mcroeconomic Imblnce Procedure tht ws dopted in December 2011 (see Europen Commission, 2012). This pper lrgely builds on the work of Buldorini et l. (2002), which provides detiled description of the frmework for clculting effective exchnge rtes dopted by the nd NCBs fter the foundtion of the euro re. Buldorini et l. note tht the s methodology for constructing EERs combines the frmework used by the Bnk for Interntionl Settlements (s per Turner nd Vn t dck, 1993), with euro re-specific components. We present n updted version of this methodology. In prticulr, we highlight the modifictions tht hve been introduced since the publiction of the pper by Buldorini et l. (2002), i.e. s regrds the prtner countries included in the EER indices, the pproch used to clculte trde weights nd the choice of defltors for the REERs. Hence, similr to Buldorini et l., this pper ims t providing comprehensive reference guide for reserchers nd users of the s euro EERs. Moreover, it presents n overview of existing stte-of-the-rt methodologies for clculting effective exchnge rtes. To this end, we explin the methodologicl choices mde by the Eurosystem, highlight the positive nd negtive spects of these choices, present potentil venues for future enhncement of the indices nd provide comprison with the methodologies of other interntionl institutions (see Tble A in the Appendix). 2 This is conventionlly mesured, for exmple, by the rtio of combined exports nd imports to GDP. 1 INTRODuCTION 7

10 There re two min peculirities with regrd to the clcultion of EERs for the euro re: first, in order to obtin long time series, the ntionl exchnge rtes of the originl 11 euro re legcy currencies need to be ggregted for the period before 1 Jnury 1999, the dte on which the single currency ws introduced s n ccounting currency. Second, s the composition of the euro re chnges over time, with the entry of ech new Member Stte, the EERs need to be flexible to tke these chnges into ccount. 3 The methodology for constructing the euro REERs is lso used to clculte hrmonised competitiveness indictors for individul euro re Member Sttes. While intr-euro re trde flows re not considered in the clcultion of trde weights for euro EERs, they re used for the HCIs, which re constructed from the perspective of individul Member Sttes. Hence, ll other euro re countries re considered s trding prtners. The HCIs re highly relevnt, s they show competitiveness developments for ech individul euro re Member Stte. Hence, the HCIs illustrte how domestic fctors, notbly price nd wge developments, ffect the interntionl competitiveness of euro re countries, lso vis-à-vis fellow Member Sttes. The reminder of the pper is orgnised s follows. Section 2 explins in detil the methodology for clculting the euro EERs: first, it presents the trde bsis of the necessry weighting scheme, trding prtners, theories nd formule, regulr updtes nd ptterns of trde weights over time. Second, it describes the theory nd defltors for the REERs nd then explins the ggregtion of the euro s legcy currencies for the period before 1999 s well s the djustments of the EERs following euro re enlrgements. Section 3 discusses the evolution of the EERs of the euro since its introduction nd presents evidence on developments in the competitiveness of the euro re s whole nd of individul Member Sttes bsed on REER indices nd HCIs respectively. Lstly, Section 4 provides some conclusions. 3 Greece joined the euro re in 2001, Sloveni in 2007, Cyprus nd Mlt in 2008, Slovki in 2009 nd Estoni in

11 2 METHODOLOGY FOR CALCuLATING THE EFFECTIVE EXCHANGE RATES OF THE EuRO This section describes the methodology behind the effective exchnge rtes of the euro. Tking economic theory nd dt constrints into ccount, it presents the options vilble for constructing the nominl nd rel effective exchnge rtes of the euro nd the choices eventully mde. In prticulr, it discusses the weighting method (bsed on the theoreticl foundtions outlined by Armington, 1969) nd set of defltors used to compile the REERs. Hrmonised competitiveness indictors for individul euro re Member Sttes re lso constructed using the sme methodology. 2.1 TRADE BASIS It is common prctice to use bilterl trde s the bsis for determining the weight of the different bilterl exchnge rtes included in the clcultion of n effective exchnge rte; the ide being to ssign greter weight to those countries ccounting for higher proportion of n economy s foreign trde. Trde flows cn be brodly clssified into three min ctegories: mnufctured goods, commodities nd services. As outlined by Buldorini et l. (2002), the EERs of the euro re bsed on mnufctured goods trde weights, with such trde being defined s per Sections 5 to 8 of the Stndrd Interntionl Trde Clssifiction (SITC). 4 Choosing mnufctured goods trde to clculte the weights is consistent with the prctice of mny interntionl orgnistions nd centrl bnks, most notbly the BIS. 5 This type of trde ccounted for bout 61% of totl euro re exports nd 49% of totl euro re imports of goods nd services in 2009, nd is generlly deemed most responsive to developments in competitiveness. In ddition, high qulity dt re vilble for brod set of countries. 6 Thus, the s weighting scheme does not reflect ptterns of trde in griculturl products, rw mterils, energy products or services. Commodities re not included, s these re considered to be homogeneous goods whose prices re determined in globl mrkets without being influenced by the competitiveness of individul countries. Indeed, including trde in griculturl or mining products my distort the competitiveness nlysis, s such goods re often hevily regulted or subsidised. From conceptul point of view, it would be desirble to include services trde in the weighting scheme, s mny different types of services re subject to competition in globl mrkets. This would be prticulrly importnt if ptterns in services trde flows were to differ significntly from those observed for mnufctured goods. However, despite improvements in the coverge of bilterl services trde flows over the lst decde, there re still considerble dt gps compred with dt on trde in mnufctured goods. Nevertheless, services trde weights re used by number of institutions (gin, see Tble A in the Appendix). For exmple, the Bnk of Englnd uses bilterl services trde dt from the Office for Ntionl Sttistics of the United Kingdom (UK; Lynch nd Whitker, 2004) nd the Interntionl Monetry Fund (IMF) includes trde in services by using the sme weights s for mnufctured goods, while tourism flows re used for those countries where these re sizeble (Byoumi et l., 2005); the Hong Kong Monetry Authority clcultes REER bsed solely on services trde vis-à-vis smll group of prtner countries (H nd Fn, 2003). As regrds the euro, Di Muro et l. (2008) hve constructed n experimentl effective exchnge rte bsed on bilterl services trde with regrd to 24 prtner countries. They conclude tht simple services trde weights (i.e. ones without third mrket effects) re typiclly higher thn mnufcturing-relted weights for trde between the euro re nd dvnced countries such s the United Kingdom nd the United Sttes, 4 These ctegories comprise chemicls nd relted products, mnufctured goods, mchinery nd trnsport equipment, nd miscellneous mnufctured rticles. 5 See Tble A in the Appendix for detiled comprison of the methods used by different orgnistions to clculte effective exchnge rtes. 6 The dt sources for bilterl trde in mnufctured goods re Eurostt, the OECD, nd the United Ntions. 2 METHODOLOGY FOR CALCuLATING THE EFFECTIVE EXCHANGE RATES OF THE EuRO 9

12 while reltively smller for trde between the euro re nd emerging economies. Given the incresing vilbility of dt for both bilterl trde in services nd relted price indices, n extension of the trde bsis to include services my become fesible in the future. 2.2 TRADING PARTNERS The EERs of the euro re currently clculted ginst two min groups of trding prtners, i.e. the EER-20 group nd the brod EER-40 group: 7 EER-20: this group is composed of the noneuro re EU Member Sttes (Bulgri, Czech Republic, Denmrk, Ltvi, Lithuni, Hungry, Polnd, Romni, Sweden nd the United Kingdom), plus Austrli, Cnd, Chin, Hong Kong, Jpn, Norwy, Singpore, South Kore, Switzerlnd nd the United Sttes. EER-40: in ddition to the trding prtners in the EER-20, the EER-40 includes Algeri, Argentin, Brzil, Chile, Croti, Icelnd, Indi, Indonesi, Isrel, Mlysi, Mexico, Morocco, New Zelnd, the Philippines, Russi, South Afric, Tiwn, Thilnd, Turkey nd Venezuel. 8 The selection of countries is bsed on their importnce s trding prtners of the euro re nd on dt vilbility, prticulrly in respect of the high qulity dt on price nd cost indictors required for clculting the REER CALCuLATING THE NOMINAL EFFECTIVE EXCHANGE RATES OF THE EuRO THEORY AND FORMuLAE The nominl effective exchnge rte (NEER) of the euro is clculted s the geometric weighted verge of bsket of bilterl nominl exchnge rtes: N w = e t i NEER t ( (1) i=1 i,euro ( where N stnds for the number of competitor countries in the reference group of trding t prtners, e i,euro is n index of the verge exchnge rte of the currency of prtner country i vis-à-vis the euro in period t (expressed in terms of foreign currency per euro), nd w i is the trde weight ssigned to the currency of trding prtner i. It is common prctice to use geometric verges rther thn rithmetic verges for clculting effective exchnge rtes. Exchnge rte indices bsed on geometric verging hve the convenient feture tht the logrithm of the index is equl to the rithmetic verge of the logrithms of the underlying bilterl rtes. As Brodsky (1982) notes, percentge chnge in the geometriclly verged effective exchnge rte between two periods is independent of the bse period. However, when n rithmetic verge is pplied, it is ffected by ll movements since the bse period. Moreover, for geometriclly verged EERs, proportionlly equivlent currency pprecitions nd deprecitions hve the sme effect (with opposing signs) on the overll index, wheres there is n upwrd bis in rithmeticlly verged indices In ddition, the publishes indices vis-à-vis nrrow group of 12 prtner countries (the EER-12, comprising Austrli, Cnd, Denmrk, Hong Kong, Jpn, Norwy, Singpore, South Kore, Sweden, Switzerlnd, the United Kingdom nd the United Sttes). This is becuse, for some of the countries included in the EER-20 (nd thus the EER-40), the historicl dt do not llow for the production of n EER over long period, strting from the 1980s. 8 The composition of the two groups chnges in the cse of n enlrgement of the euro re, s the joining Member Sttes re removed from the group of trding prtners. 9 For the ske of brevity, ll trding prtners re herefter referred to s countries irrespective of their legl sttus s territoril entity. To be included in the nrrow group of countries, Buldorini et l. (2002) mention the following selection criteri: (i) significnt trde links with the euro re; (ii) the vilbility of exchnge rte dt on dily bsis; nd (iii) the vilbility of dt relted to sufficiently brod rnge of price nd cost indices on monthly or qurterly bsis with ll dt to be reltively timely nd relible. For inclusion in the brod group, one or more of the following fetures re necessry: (i) n individul shre of totl euro re mnufcturing trde lrger thn 1%; (ii) EU ccession country sttus; (iii) significnt trde links with individul euro re countries; nd (iv) timely nd relible vilbility of monthly CPI dt. 10 For exmple, under geometric EER, ceteris pribus pprecition of 5% (x 1 =x 0 *1.05) in the currency of trding prtner would produce symmetric effect of deprecition of 4.76% (x 1 =x 0 /1.05). 10

13 WEIGHTING METHOD The pproch used for clculting the effective exchnge rtes of the euro follows the BIS methodology presented in Turner nd Vn t dck (1993). Under this method, import weights re ech trding prtner s simple shre of totl euro re imports. Export weights, on the other hnd, re double-weighted to ccount for third mrket effects. Consequently, they cpture the effect of competition fced by euro re exporters in foreign mrkets from both domestic producers nd exporters from third countries. The overll weight of ech prtner country i in the brod group of trding prtners is obtined s the weighted verge of the export nd import weights, tht is: m im x w w i = x +m + x +m, i=1,2,..., N (2) where w im nd w ix re prtner country i s import nd export weights, respectively, nd m nd x re totl imports nd totl exports by the euro re, respectively. The import weight of competitor country i is clculted s its simple shre of totl euro re imports: w i m m / N i m i i =1 =, i= 1,2,..., N w i x (3) where m i denotes gross import flows into the euro re from country i during the reference period. Hence, this mesure cptures the reltive importnce of ech of the prtner countries in totl euro re imports. It lso implies tht, the higher the shre of country i in totl euro re imports, the greter the weight of its exchnge rte in the bsket of currencies included in the EER of the euro. In order to cpture the effect of competition fced by euro re exporters from domestic producers in the economies of the trding prtners, the domestic supply of mnufctured goods in these countries is included in the clcultion of export weights. The export weights lso tke into ccount ech trding prtner s bilterl exports to different foreign mrkets. In this wy, the trde weights lso reflect the competition fced by euro re exporters in ech given foreign mrket from exporters of the countries included in the group of trding prtners. For this purpose, distinction is mde between N, the trding prtners, nd, R, the group of countries referred to s the rest of the world (whereby H = N + R, with H being the totl number of export mrkets). It is ssumed tht the euro re nd the N competitor countries re the only suppliers of mnufctured goods in the R countries. Hence, the clcultions neither include exports from the rest of the world to the N trding prtners, nor the rest of the world s domestic mnufcturing output. The shre of ech mrket in totl euro re exports is clculted s xj=, j=1, 2,..., H x / H j x j j =1 (4) where x j denotes the gross export flows in the reference period from the euro re to mrket j. The subsequent djustment of export shres to cpture third mrket effects yields the double export weights of ech prtner country i, i.e. w x H i j =1 = ( S x ), i= 1,2,..., N i, j j (5) S i,j is the shre of country i s supply in mrket j, which is obtined s: S i, j = S i,j / N S i =1 i, j (6) where S i,j (for i j, i=1, 2,, N, nd j=1, 2,..., H) denotes the gross export flows from country i to mrket j, nd S i,i (for i=1,2,, N) represents the gross mnufcturing output of country i tht is sold in its domestic mrket. S i,i serves s proxy for the gross vlue of the domesticlly produced supply of mnufctured goods. For ech country, it is obtined by dding mnufctured goods imports to the vlue dded of the mnufcturing sector nd then subtrcting mnufctured goods exports. Imports of mnufctured goods re used s proxy for both domestic non-mnufctured inputs nd imported inputs. According to Turner nd Vn t dck (1993), this method cn be used to obtin n estimte of the 2 METHODOLOGY FOR CALCuLATING THE EFFECTIVE EXCHANGE RATES OF THE EuRO 11

14 gross vlue of the mnufctured goods produced nd sold domesticlly which is comprble with interntionl trde dt tht re lso expressed in similr (gross vlue) terms. 11 In n lterntive, but equivlent wy to eqution (5), one cn decompose the double export weights (s per Turner nd Vn t dck, 1993) to disentngle direct export competition nd third mrket competition: w x i = H 1 k =1, k i xi H x j j =1 x k H x j j =1 Si, i + N S j, i j =1, j i Si, i ( ) S i, k N S i, k i =1, i k S + ( ) k, k +, i = 1,2,, N (7) where x denotes the euro re s exports to i H mrket i, x is the sum of euro re exports j j =1 to ll mrkets H. S i, i represents the domestic N production of country i, while ( Sj, i ) denotes j =1, j i gross export flows from ll N competitor countries to mrket i. The first term of eqution (7) mesures the direct competition fced by the euro re in economy i from domestic mnufcturers. Hence, the weight is greter if i is n importnt export mrket for the euro re nd if i s shre of domesticlly produced nd sold goods in totl domestic supply is lrge (i.e. i is reltively less open to foreign mnufctured goods). The second term of eqution (7) shows the third mrket effect, i.e. the competition fced by euro re exporters in ll H foreign mrkets (excluding i s domestic mrket) from exporters of economy i: one considers the shre of euro H re exports k/ x j to ech mrket k, nd the j =1 exports S i,k of economy i to mrket k, divided N by S k,k + S i, k which includes the domestic i =1, i k x ( ) supply in economy k (except for rest of the world countries, whose domestic supply is not N tken into ccount) nd the exports ( S i, k) of i =1, i k ll N competitor economies to mrket k. Hence, the weight of i s currency in the euro re s EER is greter if i is n importnt exporter to foreign mrket which is key destintion for euro re exports. The trde weights for the nrrower reference groups (i.e. the EER-12 nd EER-20) re clculted by rescling the overll trde weights obtined under eqution (2) for the EER-40 group, s per eqution (8) below. This represents chnge in methodology compred with tht outlined in Buldorini et l. (2002), where set of weights is clculted seprtely for ech trding prtner group ccording to slightly different formule. Using the new method implies tht the trde weights of the smller trding prtner groups cn be obtined by proportionlly rescling the corresponding country trde weights in such wy tht they dd up to 100. For exmple, in the cse of N, brod group of 40 prtner countries nd, M, nrrow group of 20 countries (i.e. M < N), the overll trde weight of country i in the nrrow group (w i(nrrow) ) is clculted from the weights of the brod group (w i(brod) ) using the following formul: w i(nrrow) = w i(brod) M w i(brod) i=1 (8) Effective exchnge rtes clculted in this wy hve the useful feture tht vrious combintions of sub-indices re consistent with the overll EER index for the brodest group of countries. Using the rescling pproch enbles ll vilble informtion on trde nd domestic supply conditions in the lrgest group of countries to be tken into ccount, nd thus limits the potentil for bis to just the rest of 11 The dt on the gross vlue dded of the mnufcturing sector re retrieved from vrious sources (minly from the United Ntions Ntionl Accounts dtbse). 12

15 the world countries. In fct, by employing the former method of clculting seprte weights for ech smller group of trding prtners, one excludes informtion on sizeble number of countries, thereby introducing (potentilly significnt) distortions in the clcultions. 12 DOuBLE EXPORT WEIGHTS IN PRACTICE How re double export weights obtined in prctice? All of the elements involved in the relted clcultions for the EER-40 group cn be observed in Tble 1. Pnel 1.1 of Tble 1 reports the simple percentge shre of euro re mnufctured goods exports destined for ech of the 40 prtner countries plus the ggregte for the rest of the world. For exmple, 1.28% of such euro re exports go to Austrli, 1.17% to Cnd, 2.11% to Denmrk, etc. The supply structure mtrix of the competitor countries in the brod group is presented in the second pnel of Tble 1. Ech element in this pnel (S i,j ) excluding those on the min digonl represents the percentge of mnufctured goods produced in one of the N competitor countries (cross the rows) tht is exported brod to one of the H foreign mrkets (cross the columns). The elements on the min digonl of the supply structure mtrix (S i,i ) stnd for the percentge of totl mnufctured goods tht is ccounted for by domestic production in ech of the competitor countries. Tking the first column of Pnel 1.2 s n exmple, it cn be seen tht, in Austrli, 68.57% of the totl supply of mnufctured goods is due to domestic production, while 0.41% is ccounted for by imports from Cnd, 0.18% by imports from Denmrk, nd so forth, with ll these percentges totlling to 100%. To obtin the double export weights shown in the third pnel of Tble 1 ech row of the supply structure mtrix (Pnel 1.2) is multiplied by the simple euro re export shres (Pnel 1.1), s defined in eqution (5). For exmple, the double export weight of 1.48% ssigned to Austrli in the brod EER index of the euro is obtined s follows: (1.28% 68.57%) + (1.17% 0.08%) (14.34% 0.76%). The double export weight ssigned to Austrli mesures the competition fced by euro re exporters from Austrlin producers in both the Austrlin mrket s well s in ll of the other mrkets. Only 0.88 percentge points (1.28% 68.57%) of Austrli s double export weight (1.48%) is due to competition encountered by euro re exporters in the Austrlin mrket, while the reminder stems from third mrket competition. updating OF TRADE WEIGHTS The trde weights for the effective exchnge rtes of the euro re time-vrying s they re clculted over non-overlpping three-yer periods. An dvntge of using three-yer verges, s opposed to trde weights tht re updted more frequently, is the smoothing out of potentilly lrge short-term fluctutions in trde flows. Moreover, more frequent updting lso entils dditionl dt revisions, which could complicte the nlysis of competitiveness developments. Using time-vrying weights hs the dvntge of giving n ccurte picture of both current trde ptterns, s well s those for pst periods. As noted by Klu nd Fung (2006), this ensures tht the EERs ccurtely reflect medium to long-term exchnge rte movements by tking ccount of the vrying importnce of different trding prtners t different points in time. 13 In 1999, the first set of trde weights employed to clculte the euro EERs ws bsed on trde dt for the three-yer period These were kept constnt until 2004, when the weights for the period were reclculted on the bsis of dt revisions for tht period, nd new trde weights were determined for the three yers from 1999 to Buldorini et l. (2002) describe this problem in footnote Using moving verges of trde weights (e.g. over three-yer period) is nother pproch tht would smooth out short-term fluctutions. This method, however, would be subject to nnul updtes nd revisions. 2 METHODOLOGY FOR CALCuLATING THE EFFECTIVE EXCHANGE RATES OF THE EuRO 13

16 Tble 1 Trde weight clcultions for the EER-40 group (percentges) Austrli Cnd Denmrk Hong Kong Jpn Norwy Singpore South Kore Sweden 1.1 Euro re exports Euro re exports Supply structure mtrix Austrli Cnd Denmrk Hong Kong Jpn Norwy Singpore South Kore Sweden Switzerlnd United Kingdom United Sttes Bulgri Czech Republic Hungry Ltvi Lithuni Polnd Romni Chin Algeri Argentin Brzil Chile Croti Icelnd Indi Indonesi Isrel Mlysi Mexico Morocco New Zelnd Philippines Russi South Afric Tiwn Thilnd Turkey Venezuel Totl Double export weights Export weights Import weights Import weights Overll weights Overll weights

17 2 METHODOLOGY FOR CALCuLATING THE EFFECTIVE EXCHANGE RATES OF THE EuRO Switzerlnd United Kingdom United Sttes Bulgri Czech Republic Hungry Ltvi Lithuni Polnd Romni Chin Algeri

18 Tble 1 Trde weight clcultions for the EER-40 group (cont d) (percentges) Argentin Brzil Chile Croti Icelnd Indi Indonesi Isrel Mlysi 1.1 Euro re exports Euro re exports Supply structure mtrix Austrli Cnd Denmrk Hong Kong Jpn Norwy Singpore South Kore Sweden Switzerlnd United Kingdom United Sttes Bulgri Czech Republic Hungry Ltvi Lithuni Polnd Romni Chin Algeri Argentin Brzil Chile Croti Icelnd Indi Indonesi Isrel Mlysi Mexico Morocco New Zelnd Philippines Russi South Afric Tiwn Thilnd Turkey Venezuel Totl Double export weights Export weights Import weights Import weights Overll weights Overll weights Source:. Note: Countries re ordered lphbeticlly, ccording to their introduction to the vrious groups. Hence, those countries included in the EER-12 bsket re presented first followed by those dded to form the EER-20 bsket nd ll other remining countries. 16

19 2 METHODOLOGY FOR CALCuLATING THE EFFECTIVE EXCHANGE RATES OF THE EuRO Mexico Morocco New Zelnd Philippines Russi South Afric Tiwn Thilnd Turkey Venezuel Other Countries Totl

20 In 2007, the Eurosystem decided to updte the trde weights more frequently. As result, since 2009, trde weights hve been updted every three yers (i.e. insted of every five yers) for more timely reflection of recent developments in the pttern of interntionl trde. The weighting scheme for , s clculted in 2004 nd s djusted fter euro re enlrgements, ws mintined under the second updte of In ddition, new trde weights were clculted on the bsis of revised mnufcturing trde dt for the three-yer periods , nd Besides these two updtes, the trde weights hve been reclculted following ech enlrgement of the euro re. In the third nd most recent updte crried out in Jnury 2012, ll existing periods were updted with revised mnufcturing trde dt; moreover, trde weights for the period were lso included. As result, five sets of weights re currently vilble, bsed on trde dt for the periods , , , nd For the EERs of the euro, fixed chin-linking on three yerly bsis is used. This mens tht the indices re chin-linked t the end of ech period. A disdvntge of chin-linking is tht chnges in trde weights hve permnent effect on EERs, even when exchnge rtes nd weights revert to initil levels (Klu nd Fung, 2006). 14 Menwhile, centrl rgument in fvour of more frequent updtes concerns the development of emerging mrket economies (most notbly Chin) s importnt globl trding prtners over the lst decde. Consequently, less frequent updtes of trde weights my result in bised effective exchnge rte. 15 Di Muro et l. (2008) hve constructed n effective exchnge rte of the euro using qurterly time-vrying weights for the euro re s 24 most importnt trding prtners nd find tht the impct of more frequent updtes is reltively limited there is devition of bout 4%, t most, compred to the officil euro EER. Moreover, t higher updting frequencies, third mrket effects cnnot be clculted due to dt vilbility constrints. PATTERNS OF TRADE WEIGHTS In recent yers, the geogrphicl composition of euro re trde hs undergone significnt chnge, which is lso reflected in the trde weights of the EERs of the euro. In prticulr, the growing importnce of emerging economies nd the stedily intensifying integrtion of economies in Europe re incresingly shping the trde linkges of the euro re. Tble 2 presents the verge trde weights of ech country included in the brod EER-40 group for ll vilble periods. Advnced economies continue to ccount for sizeble shre of totl euro re trde, lthough the importnce of the lrgest dvnced economies in the EER-40 of the euro hs been declining over time. Between 1995 nd 2009, the two individul countries with the gretest weights were, on verge, the United Sttes nd the United Kingdom, which together ccounted for lmost one-third of the EER-40 bsket. With Jpn, they lso were mong the euro re s three lrgest single trding prtners in the erly period , with combined weight of, on verge, round 45% of the EER-40 bsket. However, their combined shre in this bsket declined to round 30% in the period The decrese in the shre of the lrgest dvnced economies in the EER-40 bsket is not due to decline in trde with the euro re, but reflects insted the growing importnce of other regions in the globl economy, in prticulr, the emerging mrket economies. As consequence, the combined weight of trding prtners from emerging Asi in the EER-40 incresed from below 19% in the period to bove 27% in the period This expnsion results lmost exclusively from substntil increse 14 See Ellis (2001) for more detils on the chin-linking of effective exchnge rtes. 15 The Bnk of Englnd uses time-vrying smple of trding prtners (Lynch nd Whitker, 2004): country is included if its verge trde weight over the previous three yers is higher thn specified threshold vlue (1% for nrrow group nd 0.5% for broder group of trding prtners). 18

21 Tble 2 Trde weights of countries in the EER-40 group (percentges) Country Period Averge Chnge vs United Sttes United Kingdom Chin Jpn Switzerlnd Sweden Polnd Czech Republic South Kore Turkey Russi Denmrk Hungry Tiwn Indi Hong Kong Cnd Singpore Brzil Mexico Mlysi Norwy Romni Thilnd South Afric Isrel Austrli Indonesi Morocco Croti Philippines Bulgri Argentin Chile Algeri Lithuni Venezuel Ltvi New Zelnd Icelnd Totl Source:. Note: trde weights for the EER-20 nd EER-12 cn be obtined by proportionlly rescling the corresponding countries' trde weights in such wy tht they dd up to METHODOLOGY FOR CALCuLATING THE EFFECTIVE EXCHANGE RATES OF THE EuRO of bout 10 percentge points in the weight of Chin this becme the euro re s lrgest single trding prtner in the period By contrst, the combined weight of the remining BRICs, i.e. Brzil, Indi nd Russi, incresed only mrginlly by 1.7 percentge points, nd the shre of emerging Asin economies other thn Chin hs remined brodly unchnged over time. These trends re ll visible in Chrt 1, which presents developments in the trde weights of mjor regions in the globl economy, s well s those of the euro re s lrgest single trding prtners. Historiclly, in terms of combined weight, the lrgest group of trding prtners in the EER-40 bsket is tht of other Europen countries : the weight of this group incresed stedily from 19

22 Chrt 1 Evolution of trde weights in the EER-40 bsket (percentges) Chrt 2 Comprison of trde weights for individul countries nd country groups in the EER-40 bsket (percentges) United Sttes Chin other countries United Kingdom Jpn other Europen countries other Asin countries totl weight import weight double export weight export weight Source: United Sttes United Kingdom Other Europen countries Chin Source: Jpn Other Asin countries Other countries slightly bove 25% in the period to bove 30% in the period The growing importnce of other Europen economies s mjor trding prtners reflects their geogrphicl proximity nd the incresing politicl, institutionl nd economic integrtion within Europe. In fct, the increse in the weight of this group of countries is lrgely explined by the non-euro re Member Sttes tht hve joined the Europen Union since Since , their combined weight hs doubled to bove 14% of the EER-40 bsket, which corresponds to more thn eight times their combined shre of globl GDP nd thus underlines the prticulr importnce of trde linkges between these countries nd the euro re. Geogrphicl chrcteristics re lso reflected in the composition of trde weights in terms of the contribution of import nd export weights. Chrt 2 displys comprison of totl trde weights with the import weights nd double export weights tht re used for their clcultion. For illustrtive purposes, simple export weights which ignore third mrket effects re lso plotted. In the cse of mjor dvnced nd other Europen economies, the simple export weight generlly exceeds the import weight on ccount of the bilterl trde surpluses of the euro re with these countries. The opposite holds true for emerging Asin economies with which the euro re hs n ggregte bilterl trde deficit, reflecting the strong export orienttion of these economies. At the sme time, ccounting for third mrket effects leds to some djustment in the overll trde weights vi the double export weights. In prticulr, in the cse of Chin (nd lso Jpn nd other Asin economies), competition between euro re nd Asin exporters in third countries results in significnt increse in the overll trde weight ssigned to these countries; one beyond the levels implied by direct export linkges. 20

23 CAVEATS Effective exchnge rtes constructed in the wy described in this pper rely on the theoreticl foundtions outlined by Armington (1969). In prticulr, it is ssumed tht there is only one type of good, which is differentited by the country of origin nd exhibits constnt elsticity of substitution. As highlighted by Klu nd Fung (2006), there re some cvets with regrd to these ssumptions. First, the elsticity of substitution between imports from different countries my differ, given the high degree of interntionl product differentition. Hence, the effect of identicl bilterl exchnge rte movements on the domestic economy, tking into ccount the respective trde weights, my vry cross trding prtners. Second, due to the one-good ssumption, ggregte mnufcturing trde dt re used for ech country. This pproch does not tke into ccount the fct tht elsticities of substitution my differ cross vrious types of mnufctured goods. Added to this, demnd for such goods my hve different price nd income elsticities. More specificlly, this ssumption hs dverse consequences if the product mixes of two competing economies differ substntilly, s my be the cse when compring dvnced nd emerging economies (s in the EER-40 index). Furthermore, verticl specilistion implies tht products from different countries often do not compete with ech other but re complementry prts of the interntionl supply chin, which, for exmple, is relevnt for emerging Asin countries. This cn led to bised trde weights, s gross vlue trde dt my obscure the vlue dded t different stges of production. Moreover, for countries involved in interntionl supply chins, this my imply tht imports (intermedite goods) nd exports (finl goods) re complements. As production becomes more specilised cross the globe, the elsticity of substitution between goods from different countries my vry even more. POTENTIAL EXTENSIONS As indicted bove, given improved dt coverge trde weight clcultions could be extended in the future by brodening the underlying bsis to trde in services. In ddition, some enhncements to the method used for clculting trde weights for EERs hve been proposed over the lst decde. 16 In the light of incresing globl trde linkges nd country-specific product specilistion, it my be importnt to tke into considertion the sectorl composition of trde. This is prticulrly relevnt in ssessing third mrket effects, s two countries tht export to the sme third mrket my not be direct competitors if they sell very different bskets of goods. Esteves nd Reis (2006) propose triple-weighted REER in order to cpture the sectorl spects of competition: first, double weighted export weights re clculted t sectorl level; second, these sector-specific export weights re ggregted using the weights of ech sector in totl mnufcturing exports. Di Muro et l. (2008) compre triple-weighted REER index of the euro with the double-weighted euro REER index nd find the differences to be quntittively reltively smll in the cse of the euro re s whole, while they re more sizeble s regrds the HCIs of individul euro re Member Sttes. Another spect of incresed interntionl trde integrtion is the interntionlistion of production processes, including the growing trde in intermedite goods prticulrly tht directed to countries involved in the lbourintensive, ssembly stges of production. Hence, the import content of exports from these countries is reltively high, resulting in the vlue dded of domestic production being reltively 16 In ddition to the possible extensions presented, which im t improving the qulity of mesures of effective exchnge rtes vis-à-vis the nlysis of competitiveness issues, Lne nd Shmbugh (2010) hve lso developed finncil exchnge rte index. This index is weighted by the currency composition of country s interntionl investment position nd cn be pplied to the nlysis of the impct of exchnge rte movements on country s foreign ssets nd libilities. 2 METHODOLOGY FOR CALCuLATING THE EFFECTIVE EXCHANGE RATES OF THE EuRO 21

24 smll compred to the reported vlue of exports. Consequently, countries with higher thn verge shre of imported intermedite products in the production of exports receive trde weight tht is greter thn tht which would be implied by the domestic vlue dded. This could result in bis when EERs re used in order to ssess interntionl competitiveness. Di Muro et l. (2008) hve produced n lterntive EER bsed on the domestic vlue dded content of exports by employing the import content of intermedite consumption from the input-output tbles of the Orgnistion for Economic Co-opertion nd Development (OECD) s proxy for the shre of imported goods in overll exports. They find tht trde weights for industril countries tend to be higher thn under the trditionl REER index, while those of emerging Asin nd centrl nd estern Europen countries (CEECs) tend to be lower. The ggregte effect on the effective exchnge rtes of the euro is, however, not sizeble. The BIS hs introduced n djustment for entrepot trde between Chin nd Hong Kong, s substntil shre of Chin s externl trde tkes plce in the form of re-exports vi Hong Kong (Klu nd Fung, 2006). Specificlly, the BIS corrects the officil sttistics for trde between Chin nd Hong Kong by using detiled bilterl re-export dt in order to identify, for exmple, the finl destintion of Chinese exports shipped vi Hong Kong. There is some evidence tht this type of trde lso plys role in certin euro re countries, such s the Netherlnds, possibly leding to bises in the trde weight clcultions, especilly for HCIs. Currently, dt vilbility constrints for the euro re do not llow for consistent djustment of interntionl trde dt to tke ccount of entrepot trde. 2.4 THE REAL EFFECTIVE EXCHANGE RATE AND ITS DEFLATORS FORMuLAE AND THEORETICAL CONSIDERATIONS The rel effective exchnge rte serves s n indictor of interntionl price nd cost competitiveness. In ccordnce with the clcultions of the nominl effective exchnge rte, the REER of the euro is clculted s the geometric weighted verge of bilterl nominl exchnge rtes which re deflted using reltive price or cost mesures: N t t REER t d = euro e i,euro (9) i=1 d i t w i where N stnds for the number of competitor countries in the reference group of trding t prtners, e i,euro is n index of the verge exchnge rte of the currency of prtner t country i vis-à-vis the euro in period t, d euro t nd d i re, respectively, the defltors for the euro re nd prtner country i, nd w i is the trde weight ssigned to the currency of trding prtner i (s clculted in the previous section). One cn infer from eqution (9) tht it is essentil tht n pproprite defltor is chosen. Conceptully, Chinn (2006) defines the rel exchnge rte between two countries (domestic nd foreign) s: q e t + p _ p* (10) t t t where e t is the log exchnge rte expressed in terms of foreign currency per unit of domestic currency, nd p t nd p t re, the domestic nd foreign price levels (in log form), respectively. One cn decompose p t into: p = αp N + 1_ α (11) t t ( ) p t T where p t N nd p t T re the price indices of nontrdble goods nd trdble goods, respectively. 17 In ddition, indictes the shre of non-trdble goods in the domestic country s ggregte price index. Assuming n equivlent decomposition for the foreign country nd substituting eqution (11) for eqution (10), one obtins: T T* q t e t + p _ ( t p t ) + N p t pt * N * T * α ( t ) α ( p _ t p t ) (12) 17 This decomposition is possible if the price index is geometric verge of the prices of trdble nd non-trdble goods. 22

25 Hence, one cn observe three components of the rel effective exchnge rte: first, the reltive price of trdble goods cross the two countries; second, the reltive price of non-trdble goods in terms of trdble goods in the domestic country; nd, third, the reltive price of nontrdble goods in terms of trdble goods in the foreign country. One cn further simplify the formul by ssuming tht is equl to *. It then follows tht: T T * N T q t ( e t + p t p t ) + α ( p t p t ) (13) where the circumflex denotes the country difference in log terms. Chinn (2006) clls ttention to the implictions of eqution (13): if one ssumes dependent economy tht is smll reltive to the rest of the world nd is thus price-tker in globl mrkets, the focus will be on chieving n internl blnce (s represented by the second term in eqution 13). If, however, prices of trded goods re not equlised cross countries (s suggested by Engel, 1999), nd there is little vrition in the reltive price of non-trdbles, the first term of eqution (13) is the dominnt fctor for the REER. Hence, the focus will then be on the externl blnce nd price competitiveness vis-à-vis the rest of the world. Consequently, the choice of pproprite defltors depends on the two theoreticl concepts mentioned bove. Under the internl blnce scenrio, non-trdbles to trdbles price rtio would be needed. 18 Under the externl blnce pproch nd the concept of competitiveness which is predominntly used in policy discussions the producer price index could be used s mesure of trdble goods prices. Another fvoured concept is concerned with interntionl cost competitiveness (Mrsh nd Tokrick, 1996), whereby wges nd lbour productivity re used to obtin mesure of the unit lbour cost. Hence, in this cse, the REER is deflted by cost mesure. Alterntively, one cn employ the export prices of the domestic nd foreign countries to directly determine the reltive price of domestic exports. CHOICE OF DEFLATORS Aside from these theoreticl considertions, it should be noted tht there is trde-off between the concepts of choice nd the vilbility nd qulity of dt. While some indictors re vilble on monthly bsis (such s consumer prices) nd for brod set of countries, others re only published on qurterly bsis nd/or for fewer countries. The most commonly used defltor is the consumer price index (CPI). This hs the dvntge of timely nd brod dt vilbility nd lso of comprbility (being defined in similr mnner by mny countries, in prticulr, industril ones). However, CPI bskets include mny non-trdble goods nd services, while they exclude cpitl nd intermedite goods. This mkes the CPI less useful for nlysing interntionl competitiveness, prticulrly if there re significnt differences in productivity between the trdble nd non-trdble sectors. Moreover, consumer prices cn be distorted due to txes nd subsidies. The producer price index (PPI), on the other hnd, includes industril products nd intermedite goods tht cn be trded interntionlly, while it excludes retil sles. Consequently, PPIs re viewed s resonble proxy for trdble goods prices. Hving sid this, however, they exclude services prices nd their composition nd compiltion vries considerbly cross countries. The GDP defltor (GDPD) lso focuses on the production side of n economy. While this lso includes non-trdble goods, it suffers from distortions stemming from txes nd subsidies. Furthermore, GDP defltors re published less frequently thn CPIs or PPIs. 18 Chinn (2006) suggests using the rtio of the consumer price index to the producer price index for this purpose. However, he mentions severl prcticl nd theoreticl difficulties ssocited with this mesure. 2 METHODOLOGY FOR CALCuLATING THE EFFECTIVE EXCHANGE RATES OF THE EuRO 23

26 Export prices would provide direct mesure of prices in foreign mrkets. Nevertheless, there re some potentil drwbcks: export price indices re often only vilble with time lgs, subject to considerble dt revisions nd not esily comprble cross countries due to differences in the composition of export bskets. Moreover, they only include goods tht hve ctully been sold, nd typiclly do not cover trnsction prices but unit vlues. Hence, they cn chnge due to both price nd composition/ quntity movements. In ddition, export price determintion is often subject to pricing-tomrket behviour, i.e. exporters djust their prices to those previling in their export mrkets. As result, the underlying competitiveness of countries over longer periods might not be reflected. Turning to cost mesures, unit lbour costs in the mnufcturing sector (ULCM) re often used s proxy for unit lbour costs in the trdble goods sector. This populr mesure of competitiveness my, however, be too nrrow concept s it only focuses on certin sector of the economy. Using unit lbour costs for the totl economy (ULCT) hs the disdvntge tht it lso reflects costs in non-trdble goods. In generl, unit lbour cost mesures re rther voltile nd sometimes subject to significnt dt revisions. As with GDP defltors, unit lbour costs re published less frequently thn CPIs or PPIs. In ddition, they do not cover ll of the costs incurred by firms (e.g. the cost of cpitl, distribution costs nd txes re excluded). Moreover, fctor substitution my ffect these indictors without necessrily resulting in chnge in productivity. Finlly, vilble cost mesures re typiclly more ffected by dt qulity issues thn price mesures. C Zorzi nd Schntz (2008) hve empiriclly ssessed which of the bove-mentioned indictors performs best for the rel effective exchnge rtes of the euro in terms of explining export performnce. Assessing in-smple properties of estimted export equtions bsed on vrious indictors does not produce ny strong conclusions. 19 Also, with regrd to forecsting performnce, they find tht no prticulr indictor ppers consistently superior. Overll, they conclude tht, s defltors, consumer nd producer prices re good pproximtions of euro re price nd cost competitiveness conditions, prticulrly given the timeliness nd historicl vilbility of the relted dt. THE VARIOuS REAL EFFECTIVE EXCHANGE RATES The currently uses set of five defltors to clculte the rel effective exchnge rtes of the euro: consumer price indices, producer price indices, GDP defltors, nd two mesures of unit lbour costs, for the totl economy or ULCT nd in the mnufcturing sector or ULCM. The consumer price index is vilble for ll countries in the brod EER-40 group nd 19 The rel effective exchnge rte bsed on consumer prices hs mrginlly lower stndrd error. A relted test, however, suggests tht the producer price-bsed indictor ppers to perform mrginlly better. Tble 3 Overview of the defltors used to construct the rel effective exchnge rtes of the euro Defltor Definition Trding prtners Frequency Consumer price index (CPI) Hrmonised index of consumer prices EER-40 nd EER-20 Monthly Producer price index (PPI) Producer price index EER-20 Monthly GDP defltor (GDPD) Current price GDP divided EER-20 Qurterly by GDP volume Unit lbour costs in the mnufcturing EER-20 Qurterly sector (ULCM) Compenstion per employee divided by Unit lbour costs for the totl economy (ULCT) vlue dded per employee EER-20 Qurterly Source:. Note: All of the sme defltors nd frequencies re lso pplied to the EER-12 group. 24

27 thus pplied ccordingly. However, ll of the other defltors re only used for the EER-20 due to deficiencies in the qulity nd vilbility of the relted dt for certin EER-40 countries. Consumer nd producer prices re vilble on monthly bsis, while the other defltors re published qurterly (see Tble 3 bove for n overview). Where defltors re only vilble with time lg, estimtions re used. The dt re sesonlly djusted nd disggregted from nnul dt if qurterly dt re not vilble. Dt for the defltors re collected from severl sources (minly Eurostt, the OECD, the BIS nd the IMF). For both the euro re nd Europen Union countries, cost nd price mesures re bsed on hrmonised concepts. For exmple, the Hrmonised Index of Consumer Prices (ll items) of Eurostt is used for Europen countries, while similr ntionl consumer price indices re used for ll other trding prtners. GDP defltors re derived from qurterly ntionl ccounts. Unit lbour costs re clculted s the rtio of the compenstion per employee nd lbour productivity, with lbour productivity mesured s GDP t constnt prices divided by the totl number of employees. POTENTIAL EXTENSIONS A possible extension would be to construct REER bsed on export prices, idelly trnsction price indices for non-domestic sles rther thn unit vlue indices. Furthermore, producer price index covering the services sector would be desirble, given the growing importnce of the interntionl trde in services. In ddition, Esteves (2007) notes tht trditionl REERs only tke into ccount chnges in prices nd costs, nd ignore differences in their levels. Differences in price levels could be importnt from competitiveness perspective, for exmple, in the cse of n emerging mrket economy with low price level tht enters the globl mrket. Esteves introduces n indictor of reltive price levels s n lterntive defltor. This is essentilly the difference between the mrket exchnge rte nd the purchsing power prity exchnge rte. It should be noted, however, tht focusing on price levels (rther thn price chnges) hs potentil drwbcks, s differences in price levels for trdble goods my be explined by differences in qulity. Furthermore, the composition of the bsket of trdble goods my differ substntilly between two countries. 2.5 BASE PERIOD AND FREquENCY The bilterl exchnge rtes used in the clcultions re, in most cses, the s officil dily reference rtes (indictive rtes published by other interntionl orgnistions re used when these re not vilble). For the period before 1 Jnury 1999, proxies for the bilterl exchnge rtes of the euro were clculted (see Section 2.6). The nominl effective exchnge rtes for the EER-20 re vilble on dily bsis. Other indictors re vilble monthly, with the exception of the REER indices bsed on the ULCT, ULCM nd GDP defltors, which re vilble qurterly. The bse period for ll indices is the first qurter of 1999 (i.e Q1 = 100). 2.6 AGGREGATION OF PRE-1999 LEGACY CuRRENCY DATA TO PROXY THE EuRO EXCHANGE RATE As euro exchnge rtes hve only been vilble since the strt of Stge Three of the EMU, erlier EER dt re bsed on bsket of the currencies of those countries tht formed the euro re in Jnury The weights for the pre-1999 theoreticl euro exchnge rtes re bsed on the shre of ech euro re country in the totl mnufcturing trde of the euro re vis-à-vis non-euro re countries (from 1995 to 1997). The theoreticl euro exchnge rte for the time until 31 December 1998 is obtined by 20 The 11 initil euro re Member Sttes re Austri, Belgium, Finlnd, Frnce, Germny, Irelnd, Itly, Luxembourg, the Netherlnds, Portugl nd Spin. 2 METHODOLOGY FOR CALCuLATING THE EFFECTIVE EXCHANGE RATES OF THE EuRO 25

28 ggregting the exchnge rtes of the ntionl currencies of the 11 initil euro re Member Sttes ccording to the following formul: = 11 w e k e i,euro ei, k k =1 ( ), i = 1, 2,...,N (14) where e i,euro is the proxy for the exchnge rte of the currency of prtner country i ginst the euro before 1999, 11 is the number of EMU legcy currencies, N stnds for the number of prtner countries, nd e i,k is the exchnge rte of the currency of prtner country i ginst euro re country k s legcy currency. The weight for ech individul euro re country (mong the first 11 Member Sttes) corresponds to its shre in the totl gross trde flow of the euro re: union is excluded from the groups of euro re trding prtners nd included in the computtion of euro re dt. The overll trde weights nd finl EERs of the euro, s well s the HCIs of euro re countries, re ll reclculted to reflect the chnged composition of the euro re nd its groups of trding prtners. Two sets of indices re clculted: one which reflects the physicl expnsion of the euro re over time (i.e. the index for 11 countries until end-2000, for 12 countries from 2001 to 2006, nd so forth). For the other set, which is lso the one most commonly used, countries tht joined the euro re t lter stge re treted s if they hd been in the currency union since its inception. e k 11 k k k= 1 w = t / t, k = 1, 2,,11 (15) where t k denotes the gross trde flow of euro re country k. The totl gross trde flow of the euro re is defined s totl euro re exports to the H foreign mrkets plus totl euro re imports from the N prtner countries in the period : 11 t k k = 1 = H x j j= 1 + N m i i= 1 (16) The resulting theoreticl euro composite indictor summrises the exchnge rte developments of the countries which formed the euro re in Jnury 1999, thereby providing synthesis of the externl vlue of euro re currencies in the 1990s ADJuSTMENTS IN THE EFFECTIVE EXCHANGE RATES OF THE EuRO DuE TO EuRO AREA ENLARGEMENTS The trde weights underlying the euro EER which re reported in Tble 1 tke ccount of the euro re enlrgements of 2001 (Greece), 2007 (Sloveni), 2008 (Cyprus nd Mlt), 2009 (Slovki) nd 2011 (Estoni). Specificlly, following n enlrgement of the euro re, the country joining the monetry 21 Only one weight is given to ech of the 11 currencies, ssuming implicitly tht the importnce of given country s trde in overll euro re trde is the sme with regrd to ll individul competitor countries (i.e. Germny s shre in euro re trde with the United Sttes is the sme s tht for trde with the United Kingdom, Jpn nd the other prtner countries). As the trde importnce of ech prticipting country my vry cross the competitor countries, one could rgue in fvour of ssigning different set of weights to ech competitor country currency. However, Buldorini et l. (2002) highlight the prcticl difficulties involved in such n pproch. In ddition, no quntittive differences between these two pproches were found when they were pplied to the NEER index of the euro. 26

29 3 EFFECTIVE EXCHANGE RATES OF THE EuRO AND HARMONISED COMPETITIVENESS INDICATORS OVER TIME This section first briefly discusses the evolution of the nominl effective exchnge rtes of the euro, focusing on some of their min trits since the beginning of the EMU. It then presents evidence on developments in the competitiveness of the euro re s whole s well s tht of individul Member Sttes, nmely bsed on euro REERs nd the HCIs of euro re countries, respectively. 3.1 NOMINAL EFFECTIVE EXCHANGE RATES OF THE EuRO The nominl EER-40 is presented in Chrt 3, together with the euro/us dollr bilterl rte the US dollr is the currency of the euro re trding prtner with the gretest verge weight (16.8%) in the EER-40 bsket between 1995 nd In ddition, the currencies of some of the euro re s most importnt trding prtners, in prticulr of countries in Ltin Americ nd Asi, were closely linked or even pegged to the Chrt 3 Nominl EER-40 nd the euro/ us dollr rte (Jnury 1999-Jnury 2012) NEER-40 (left-hnd scle) USD/EUR (right-hnd scle) Source:. Note: A downwrd movement reflects deprecition of the euro, while n upwrd movement indictes n pprecition of the single currency US dollr. The verge effective weight of the US dollr in the EER-40 bsket ws thus bout 40% during the period As result, the nominl EER-40 brodly reflects movements in the euro/us dollr bilterl rte, despite some noticeble divergences (in prticulr in the wke of the globl finncil crisis tht erupted in 2008). In first period, fter the introduction of the single currency in 1999 nd up until the end of the yer 2000, the nominl effective exchnge rte of the euro deprecited, lrgely due to n pprecition of the US dollr ginst the single currency. Therefter, in second period tht lsted until the beginning of 2004, this trend reversed s the euro strted to pprecite stedily ginst the US dollr, prompting n increse in the euro EER over this period. Since then, nd until erly 2012, the nominl effective exchnge rte of the euro hs been oscillting in reltively nrrow bnd of roughly ±5%, while the euro/us dollr bilterl rte hs fluctuted more substntilly, prticulrly since the emergence of the first finncil mrket turbulence in After this turbulence intensified nd triggered the globl finncil crisis, movements in the effective exchnge rte of the euro were, s with other finncil mrket vribles, to lrge extent ssocited with incresed risk version nd rpidly chnging finncil mrket sentiment. Initilly, the euro brodly pprecited ginst mjor currencies on ccount of incresed globl risk version, mid wide swings in its bilterl exchnge rte with the US dollr. However, this trend reversed in lte 2009 nd erly 2010, with the incresed tensions in certin euro re sovereign debt mrkets. Although the euro EER remined reltively stble therefter, the single currency continued to fluctute significntly ginst the US dollr, in line with chnging perceptions bout fiscl prospects nd the outlook for monetry nd economic policies in the euro re nd other mjor dvnced economies. A noticeble chrcteristic of the nominl EER-40 is tht, since the introduction of the single currency, it hs been less voltile thn the euro/us dollr rte s well s the bilterl 3 EFFECTIVE EXCHANGE RATES OF THE EuRO AND HARMONISED COMPETITIVENESS INDICATORS OVER TIME 27

30 rtes for most of the other floting currencies included in the EER-40 bsket. Indeed, euro NEER voltility, s mesured by the monthly stndrd devition of percentge chnges in the EER-40, hs been bout 1.5% since the inception of the EMU. To put this into perspective, this compres with figure of 2.8% for the bilterl exchnge rte of the euro ginst the Jpnese yen nd the US dollr nd the voltility of 1.8% in the euro/sterling rte over the sme horizon. This, in turn, reflects the fct tht chnges in bilterl rtes cn offset ech other in the clcultion of effective exchnge rtes nd thus lower the voltility of the ltter; perhps desirble property of the exchnge rte indictors used in empiricl economic nlysis. The NEERs of the euro constitute coherent set of indictors summrising the evolution of the euro ginst the currencies of brod set of trding prtners. As shown in Chrt 4, the nominl EER-40 is highly correlted with tht of the EER-20, which is bsed on smller set of trding prtners. In fct, the correltion between both indices reches 99%, implying n lmost perfect comovement of both mesures. This close correltion reflects the fct tht Chrt 4 Nominl EER-40 nd the nominl EER-20 (Jnury 1999-Jnury 2012) NEER-40 (left-scle) NEER-20 (right-scle) Source:. Note: A downwrd movement reflects deprecition of the euro, while n upwrd movement indictes n pprecition of the single currency the currencies included in the EER-20 bsket ccount for more thn 80% of those in the bsket for the EER-40. It lso indictes tht the EER-20 provides representtive picture of the evolution of the euro s externl vlue ginst the currencies of broder set of trding prtners. 3.2 REAL EFFECTIVE EXCHANGE RATES OF THE EuRO The close comovement between the nominl EER-20 nd EER-40 is prticulrly dvntgeous, given tht rel effective exchnge rtes (except the one bsed on CPI defltors) cn only be computed for countries included in the EER-20 due to limittions in the vilbility of dt on price nd cost developments in some of the euro re s trding prtners (s lredy described in Section 2.4). Chrt 5 demonstrtes tht most of the vrition in the CPI-bsed REER-40 is ccounted for by movements in the nominl EER-40. Furthermore, the CPI-bsed REER-40 hs devited only very slightly from the corresponding REER-20 since the introduction of the euro, i.e. by round 2% in cumultive terms. Altogether, this suggests, first, tht chnges in euro REERs re dominted by movements in euro NEERs nd, second, tht developments in reltive prices between the euro re nd countries included in the EER-20 bsket re brodly representtive of the evolution of euro re competitiveness, lso ginst broder set of trding prtners. Thus, overll, it is plusible tht REERs bsed on defltors other thn consumer prices, while only computed ginst the currencies of 20 trding prtners, still provide firly ccurte picture of the euro re s competitiveness in terms of other price nd cost mesures. In fct, the cross-correltions between the rel effective exchnge rtes bsed on different defltors rech 99% in ll cses. As result, ll but one of the euro REERs deflted by different price nd cost indictors point to slight improvement in euro re competitiveness since 28

31 Chrt 5 Nominl EER-40 nd selected REERs 125 CPI-20 CPI-40 GDP-20 NEER Chrt 6 Nominl EER-40 nd selected REERs 125 PPI-20 ULCT-20 ULCM-20 NEER EFFECTIVE EXCHANGE RATES OF THE EuRO AND HARMONISED COMPETITIVENESS INDICATORS OVER TIME Source:. Note: A downwrd movement reflects deprecition of the euro, while n upwrd movement indictes n pprecition of the single currency Source:. Note: A downwrd movement reflects deprecition of the euro, while n upwrd movement indictes n pprecition of the single currency. the introduction of the single currency. Given tht euro NEERs hve lso pprecited slightly since then, the modest deprecition of the euro tht hs tken plce in rel terms since its lunch reflects n overll lower rte of increse in the defltors compred to the euro re s min trding prtners. The only exception here is the REER-20 bsed on unit lbour costs in the mnufcturing sector, which hs pprecited since the inception of the EMU (see Chrt 6). The divergence between the REER deflted by mnufcturing sector unit lbour costs, on the one hnd, nd the REERs bsed on lterntive defltors, on the other, prtly reflects the growing importnce of emerging nd trnsition economies in the trde weights used to clculte the effective exchnge rtes of the euro (s described in Section 2.3). First, emerging nd trnsition economies re subject to process of economic convergence which is often ccompnied by grdul upwrd shift in price levels nd thus higher rtes of infltion, prompting continued rel currency pprecition. At the sme time, productivity gins in emerging nd trnsition economies re typiclly most pronounced in the mnufcturing sector. These led to reduction in unit lbour costs in this sector, which prtly explins the loss in euro re competitiveness indicted by the REER-20 bsed on unit lbour costs in the mnufcturing sector. 3.3 HARMONISED COMPETITIVENESS INDICATORS OF EuRO AREA COuNTRIES Chnges in the rel effective exchnge rte of the euro reflect chnges in the competitiveness of individul euro re Member Sttes vis-à-vis their min trding prtners outside the currency union. However, the rel effective exchnge rte of the euro does not show competitiveness developments within the euro re nd the differences in this regrd between individul Member Sttes: their competitiveness is lso shped by developments in reltive prices nd costs between the euro re countries themselves. Chrt 7 shows tht developments in the price nd cost competitiveness of individul euro re Member Sttes, compred with the rest of the euro re nd countries included in the EER-20 bsket, hve been very diverse since the inception of the euro. 29

32 Chrt 7 Hrmonised competitiveness indictors (percentge chnge between 1999 Q1 nd 2011 Q4) CPI ULCT Euro re Germny Austri Frnce Finlnd Belgium This diversity is prtly explined by the fct tht some euro re countries were subject to process of economic convergence before introducing the single currency, for exmple, those tht joined the currency union fter Hence, such countries generlly recorded higher rte of increse in prices nd costs. Hving sid this, other fctors re lso likely to hve plyed role. In fct, the divergence in competitiveness is more pronounced in the hrmonised competitiveness indictors bsed on unit lbour costs, while CPI-deflted hrmonised competitiveness indictors hve diverged less. For most euro re countries, the gp between the percentge chnge in CPI-deflted nd ULC-deflted competitiveness is ctully lrger thn tht for the euro re s whole. As result, since the beginning of the EMU, developments in prices, wges nd productivity hve tended to diverge within certin Member Sttes, lbeit whilst remining closely linked for the euro re s whole nd generlly contributing to slight improvement in euro re price nd cost competitiveness Netherlnds Itly Sloveni Portugl Spin Greece Mlt Cyprus Irelnd Luxembourg Estoni Slovki Source:. Note: Countries rnked in scending order ccording to the verge percentge chnge for the CPI-deflted nd ULC-deflted hrmonised competitiveness indictors. The vlues for the euro re re bsed on the REER-20. A negtive vlue indictes n increse in price or cost competitiveness nd vice vers.

33 4 CONCLuSION This pper provides detiled updte of the methodology for clculting euro effective exchnge rtes presented by Buldorini et l. (2002). In prticulr, it explins modifictions in the methodology tht hve been introduced over the lst decde regrding the prtner countries included in the EER nd HCI indices, the prctice of clculting trde weights nd the choice of defltors. Hence, the pper my serve s comprehensive reference guide for reserchers nd users of the s euro effective exchnge rtes. Whilst the min focus is on the pproch used to clculte effective exchnge rtes nd hrmonised competitiveness indictors, it lso highlights the dvntges nd drwbcks of the Eurosystem s choices in constructing these indices. Consequently, the pper presents possible venues for further enhncing the indices in the future nd provides comprisons with the methodologies pplied by other institutions. It lso notes the chllenges rising from dt constrints, both in respect of the qulity nd vilbility of the dt required to clculte effective exchnge rtes. In prticulr, relible dt on unit lbour costs my not lwys be vilble, s these re often voltile nd subject to significnt revisions. Furthermore, due to incomplete dt coverge regrding the cross-sectionl nd time dimension, it is still not possible to use services trde dt to the sme extent s dt on trde in mnufctured goods in the clcultion of trde weights. Finlly, the pper discusses the evolution nd min trits of the effective exchnge rtes of the euro since the inception of the Economic nd Monetry Union, nd presents evidence on developments in the competitiveness of the euro re s whole s well s of individul euro re Member Sttes. While the growing importnce of Chin is reflected in the updted trde weights of the effective exchnge rtes of the euro, it ppers tht the incresing integrtion of the euro re with other Europen economies ccounts for the lrgest vrition in trde weights. The US dollr, n nchor currency for number of lrge emerging mrkets, continues to ply n importnt role for the effective exchnge rte of the euro nd euro re competitiveness. Overll, since the introduction of the single currency, the competitiveness of the euro re hs improved slightly reltive to its min trding prtners, but there remins significnt degree of heterogeneity cross euro re countries. The hrmonised competitiveness indictors re therefore useful complement to the EERs in the nlysis of euro re competitiveness. 4 CONCLuSION 31

34 REFERENCES Armington, P. S. (1969), A theory of demnd for products distinguished by plce of production, IMF Stff Ppers, Vol. 6, pp Brodsky, D. (1982), Arithmetic versus Geometric Effective Exchnge Rtes, Weltwirtschftliches Archiv, Vol. 118, pp Byoumi, T., Lee, J. nd Jynthi, S. (2005), New rtes from new weights, IMF Working Pper, WP/05/99. Buldorini, L., Mkrydkis, S. nd Thimnn, C. (2002), The effective exchnge rtes of the euro, Occsionl Pper, No 2. C Zorzi, M. nd Schntz, B. (2007), Explining nd forecsting euro re exports: which competitiveness indictor performs best?, Working Pper, No 833. Chinn, M. (2006), A primer on rel effective exchnge rtes: determinnts, overvlution, trde flows nd competitive devlution, Open Economies Review, Vol. 17, pp Di Muro, F., Rüffer, R. nd Bund, I. (2008), The chnging role of the exchnge rte in globlised economy, Occsionl Pper, No 94. Ellis, L. (2001), Mesuring the Rel Exchnge Rte: Pitflls nd Prcticlities, Reserve Bnk of Austrli Reserch Discussion Pper, Engel, C. (1999), Accounting for US Rel Exchnge Rte Chnges, Journl of Politicl Economy, Vol. 107(3), pp Esteves, P. S. nd Reis, C. (2006), Mesuring export competitiveness: Revisiting the effective exchnge rte weights for the euro re countries, Bnco de Portugl Working Ppers, No 11. Esteves, P. S. (2007), Foreign Competitors Price Aggregtion in Computing Price Competitiveness Indictors: An Appliction to the EU15 Countries, Bnco de Portugl Economic Bulletin, Spring, pp Europen Commission (2012), Scorebord for the surveillnce of mcroeconomic imblnces, Europen Economy Occsionl Pper, No 92. H, J. nd Fn, K. (2003), Alterntive mesures of the rel effective exchnge rte, Hong Kong Monetry Authority Qurterly Bulletin, Mrch, pp Klu, M. nd Fung, S. S. (2006), The New BIS Effective Exchnge Rte Indices, BIS Qurterly Review, Mrch. Lne, P. R. nd Shmbugh, J. C. (2010), Finncil exchnge rtes nd interntionl currency exposures, Americn Economic Review, Vol. 100(1), pp

35 Lynch, B. nd Whitker, S. (2004), The new sterling ERI, Bnk of Englnd Qurterly Bulletin, Winter. REFERENCES Mrsh, I. nd Tokrick, S. (1996), An Assessment of Three Mesures of Competitiveness Weltwirtschftliches Archiv, Vol. 132(4), pp Turner, P. nd Vn t dck, J. (1993), Mesuring interntionl price nd cost competitiveness, BIS Economic Ppers, No

36 APPENDIX A comprison of different methods used by selected orgnistions to clculte effective exchnge rtes Institution Trde bsis Trding prtners Euro re clssifiction EERs of the euro Mnufctured goods (SITC 5-8) EER-40 EER-20 EER-12 Europen Commission DG ECFIN Totl goods IC41 IC36 EU27 BIS Mnufctured goods (SITC 5-8) Brod-58 Nrrow-27 Euro re s single entity The 17 euro re Member Sttes re counted indiviudlly in ll groups B58 includes 15 euro re Member Sttes nd the euro re individully 1) N27 includes 11 euro re Member Sttes nd the euro re individully Mnufctured goods (SITC 5-8) 26 countries Includes 12 euro re Member Sttes 2) EER-40 EER-20 EER-12 IC41: 24 trding prtners IC36: 19 trding prtners B58: 42 trding prtners N27: 15 Trding prtners 14 prtners IMF Federl Reserve Bord Mnufctured goods (SITC 5-8), commodities (overll weight in globl mrkets), nd services (sme weights s mnufcturing except for countries where tourism is importnt) Totl goods (excluding gold nd militry items from exports, oil from imports) 184 countries Includes 17 euro re Member 167 prtners Brod Index: 26 OITP Index: 19 Mjor Index: 7 All indices include the euro re s single entity NA Bnk of Englnd Mnufctured goods nd services Nrrow ERI: 17 countries 4) Brod ERI: 25 5) Both include the euro re s single entity Avilble 1) Estoni still fetured s non euro re member, Luxembourg excluded from nlysis. 2) Cyprus, Estoni, Mlt, Slovki, Sloveni not included individully. 3) The IMF does not updte the weights t regulr frequency, but t infrequent intervls. 4) Time vrying country coverge: included if trde weight verge over the pst three yers >1%. 5) Time vrying country coverge: included if trde weight verge over the pst three yers >0.5%. 34

37 APPENDIX EERs/HCIs of EA countries Weighting methods Updte of weights Defltors EER-20 nd EER-40 composition plus the 16 other euro re Member Sttes IC36 nd IC41 composition plus the 16 other euro re Member Sttes Weighted verge of import nd double export weights (including weighted third mrket effects) Double export weights (including weighted third mrket effects) Averge weight fixed over three yers, updted every three yers Annul weights, updted yerly CPI, PPI, GDP defltor, ULCM, ULCT CPI, GDP defltor, Export prices, ULCT, ULCM N27 composition plus 10 other e uro re M ember S ttes B58 composition plus 14 euro re Member Sttes Weighted verge of import nd double export weights (including weighted third mrket effects) Averge weight fixed over three yers, updted every three yers CPI 14 prtners + 11 other euro re Member Sttes 167 prtners + 16 other euro re Member Sttes Weighted verge of import nd double export weights (including weighted third mrket effects) Weighted verge of import nd double export weights (including weighted third mrket effects) for mnufcturing, simple weights for other ctegories Averge weight over , updted discretely 3) ULC CPI NA NA Averge of import nd double export weights (including third mrket effects), equl weights for exports nd imports Fixed weighted verge of import nd double export weights (including third mrket effects for mnufcturing) Annul weights, updted yerly Annul weights, updted yerly CPI CPI 35

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