Nominal and Real Shocks in the EURALL Exchange Rate. (A SVAR Guide)

Abstract

Exchange rates are one of the most important topics in the economic and financial sectors. Considering the exchange rate as the price between currencies, financial theories aim to understand the behavior of exchange rates from a more rational viewpoint. Domestic and foreign inflation has a direct impact on the real interest rates and the exchange rates. This paper aims to analyze the nominal and real shocks of the exchange rate between the Euro and Albanian lek [EURALL]. As the most important foreign currency used in the Republic of Albania, the euro is becoming more and more a stable determinant of prices and asset values in the Albanian economy. The vast majority of import and export is dependent on the EURALL trend. That is one of the main reasons why it is so important to study the shocks in the EURALL exchange rate. The Structural Vector Autoregressive (SVAR) models can be used to understand the effects of imposing some long-run restrictions. In addition, some short-run shocks play a major role and continue to have effects even in the long run. This paper takes into consideration the monthly data of exchange rates and inflation of Albania and the Eurozone from 2016 – 2022 (the last 7 years). As one of the most important models, SVAR models can be used in both fiscal and monetary policymaking. Studying nominal and real exchange rates means studying inflation in the eurozone and Albania. Real shocks have a significant impact on both nominal and real exchange rates. Meanwhile, there is no evidence that the nominal shocks (such as institutional interventions or central bank operations) have an important impact on the nominal and real exchange rates. Referring to that, we can conclude that policymaking institutions should be cautious about the real exchange rate.