The Equilibrium Real Exchange Rate of Lek vis-à-vis Euro

Albania opted for a flexible exchange rate from the beginning of transition not simply because of its limited international reserves but also to avoid costly adjustments of possible exchange rate misalignments that usually characterize pegged regimes. While it is tempting to intuitively judge this choice as successful, a more formal assessment of whether the exchange rate in Albania does in fact reflect fundamentals is warranted not least to highlight the importance of fiscal and monetary discipline to ensure the stability of internal and external equilibrium in absence of a very explicit anchor. This paper is a first attempt to assess the relationship between the Lek/Euro exchange rate and some key fundamentals as well as the role of other policies and factors that might disturb its equilibrium.