About 3,200 soldiers from 14 countries are taking part in the German-led Northern Coasts 23 exercise, the German navy said in a statement.
The exercise will involve 30 ships, submarines, up to 19 aircraft and various landing units, it said.
Other countries taking part include Italy, France, Finland, Estonia, Denmark, Canada, Belgium, Latvia, Lithuania, the Netherlands, Poland, Sweden and the US.
It is the first time the German navy has been charged with "planning and conducting a manoeuvre of such magnitude", said Rear Admiral Stephan Haisch, director of the manouevre.
The Northern Coasts series was launched by the German navy in 2007. Responsibility for the exercise alternates annually between Germany, Denmark, Sweden and Finland.
This year, for the first time, "a realistic scenario is being practised within the framework of alliance defence", according to the German navy.
The exercise will take place off the coasts and on the territory of Latvia and Estonia.
Incidents involving Russian and Western aircraft have multiplied over the Black Sea and Baltic Sea during Russia's offensive in Ukraine.
Moscow said in May that it had intercepted four US strategic bombers above the Baltic Sea in two separate incidents in the space of one week.
Russia regularly holds naval drills in the Baltic Sea, often in response to NATO exercises in the area.
It last held drills in the area in early August.
The Russian navy has played a key role in Moscow's assault on Ukraine by pummelling the Western-backed country with ship- and submarine-launched cruise missiles, among other weapons.