The impact of market regulations on intra-European real exchange rates

We study the contribution of market regulations to the dynamics of the real exchange rate within the European Union. Based on a model proposed by De Gregorio et al. (Rev Int Econ 2(3):284-305, 1994a), we show that both product market regulations in nontradable sectors and employment protection tend to raise the real exchange rate. We then carry out an econometric estimation for European countries for 1985-2006 to quantify the contributions of the pure Balassa-Samuelson effect and those of market regulations on real exchange-rate variations. Based on this evidence and on a counter-factual experiment, we conclude that the relative evolutions of product market regulations and employment protection across countries play a very significant role for real exchange-rate variations within the European Union and especially within the euro area, through their impacts on the relative price of nontradable goods.