Exchange rates and monetary fundamentals in CEE countries: Evidence from a panel approach

•We examine a relation between exchange rates and macrofundamentals in CEE countries.•Our methodology allows for non-stationarity and cross-sectional dependence.•Evidence of cross-sectional dependence among CEE countries is strong.•Exchange rates of CEE currencies return to the long-term equilibrium relation.•The results are not driven by the global financial crisis.

This paper examines whether the monetary model is a reasonable framework for exchange rate movements in Central and Eastern European countries. We apply the methodology for non-stationary panels, which allows for cross-sectional dependence. We also choose the timespan of data free of high inflation periods and focus on countries with relatively flexible exchange rates. Using quarterly panel data, 2001:4–2012:4, we find evidence of cointegration between exchange rates and macroeconomic fundamentals. Granger causality tests reveal that exchange rates have reverted to the long-run relation implied by the monetary model. The results obtained are not driven by the recent crisis.