Effects of the Competitive Disinflation Program in Spain on the Real Exchange Rate

Abstract

In this paper we enquire about the link among Spanish real effective exchange rate relative to the EU, the terms of trade and the real interest rate differential over the period 1980-1994. This period is of interest to the Spanish economy due to the fact that the monetary authorities were applying the so-called "competitive disinflation" strategy in the European Monetary System. The analysis draws on Meese and Rogoff (1988), using the terms of trade as an explanatory variable for the long-run performance of the real exchange rate. The empirical results show that the interest rate differential, representing the demand side factors, has been the relevant one in explaining the real exchange rate behaviour, while the terms of trade have been of a minor importance. This fact could be due to the tight monetary policy undertaken during this decade as a part of a disinflationary program as well as to the important changes occured to the financing of the public sector.