A short lesson in exchange rate determination

Willem Verhagen, senior economist at ING Investment Management, investigates which ‘fundamentals' really matter for the euro.

François Hollande, the French President, recently called for action against the strong euro, stating that the economy could end up with an exchange rate “out of line with the fundamentals”. Although plausible, exchange rates are probably “out of line with the fundamentals” most of the time. In fact, among all the variables economists try to understand, the external value of the currency is arguably the most difficult to explain. The most important long-run fundamental exchange rate drivers are inflation differentials and differences in productivity growth. Countries with a persiste...