Exchange Rates and the Supply Response in the Czech Republic: Is PPP a Relevant Rule for Assessing the Equilibrium?

The functioning of the Eastern European economies received much attention after their changeover to markets after 1989. The peculiarities in the subsequent development in these countries posed several new empirical issues to be theoretically explained. The problem of finding the equilibrium real exchange rate (RER) and exchange rate stability in these economies has remained one of the most resilient features to solve. Contrary to traditional experience in dealing with exchange rate adjustment, many of these countries, after sharp devaluations of their currencies to the level of market equilibrium, went through a long period of real appreciation. Both the economic policy-makers and the theorists were then not able to get an equivocal agreement in the interpretation of these developments. It became apparent that many rules that functioned satisfactorily in stable economies, became of ill-advice for economies in transition or for economies undergoing a fast industrial restructuring. The Czech case is a prime example of how the exchange rate could behave in the most unexpected way. Table 8.1 shows the basic indicators relevant for the assessment of the RER and the evolution of the environment influencing the RER.