Euro Area real effective exchange rate misalignments

The resolution of the eurozone crisis requires, amongst other things, successful relative price adjustments between member states. We estimate here the scale of the adjustments needed using fundamental equilibrium exchange rates. We suggest two scenarios of adjustments, depending on the levels of inflation tolerated in surplus countries and at the Euro Area level. If the ECB doesn’t temporarily increase its inflation objective, Portugal and Greece will be unable to significantly reduce their overvaluation by the end of the decade.