Real Exchange Rate and Real Economic Fundamentals in Transition Economy of Bosnia and Herzegovina (BH)

Abstract: The paper estimates Equilibrium Real Exchange Rate (ERER) using co-integration methodology to observe relationship between Real Exchange Rate (RER) and selected economic fundamental variables over two different sample periods. Time period of observation influences results and we observe change in signs and direction of relationship between fundamentals and RER suggesting that fundamentals and RER do not have a stable relationship and direction of influence. The findings suggest that RER is not a significant transmission mechanism for real economy towards achieving external balance as RER depreciation is not associated with an improvement in resource balance. Therefore, RER does not have a postulated relationship with resource balance variable. More appreciated RER is associated with an improvement in the external balance of the BH economy which is opposite of an expected role of RER depreciation in brining economy towards external equilibrium. However, pressures on RER sustainability exist due to negative resource balance. Potential disequilibria therefore could not be caught with the existing data which cover the post-war period only, and were marked by continuous negative resource balances.