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A Fair Exchange? Theory and Practice of Calculating Equilibrium Exchange Rates

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Author Info

  • Jaewoo Lee
  • Hamid Faruqee
  • Tamim Bayoumi

Abstract

We develop a theory-based model of equilibrium exchange rates incorporating factors that have been found to matter empirically. The model provides insights into how variables should be measured and what are appropriate cross-country restrictions. We estimate this model using a panel of 12 industrial countries. The model fits the data relatively well, implying relatively fast adjustment to equilibrium and outperforming a random walk at longer horizons. Furthermore, we find that the rate of adjustment depends on the distance from equilibrium, suggesting that part of the explanation for slow adjustment is inaccurate measures of equilibrium.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/229.

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Length: 28
Date of creation: 01 Dec 2005
Date of revision:
Handle: RePEc:imf:imfwpa:05/229

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Related research

Keywords: Exchange rates; Economic models; exchange rate; equation; statistics; cointegration; real exchange rate; real exchange rates; statistic; finite sample; significance level; equilibrium exchange rate; nonlinearity; independent variables; econometrics; random walk; number of regressors; effective exchange rates; normal density; statistical significance; exchange rate literature; nominal exchange rates; equations; current account balance; prediction; statistical inference; predictions; foreign exchange; estimation of equation;

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References

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  1. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
  2. Kenneth A. Froot & Kenneth Rogoff, 1994. "Perspectives on PPP and Long-Run Real Exchange Rates," NBER Working Papers 4952, National Bureau of Economic Research, Inc.
  3. Maurice Obstfeld & Kenneth Rogoff & Ben Bernanke & Kenneth Rogoff, . "The Six Major Puzzles in International Macroeconomics: Is there a Common Cause?," Working Paper 32326, Harvard University OpenScholar.
  4. Lane, Philip & Milesi-Ferretti, Gian Maria, . "External Wealth of Nations," Instructional Stata datasets for econometrics extwealth, Boston College Department of Economics.
  5. Jaewoo Lee & Man-Keung Tang, 2003. "Does Productivity Growth Lead to Appreciation of the Real Exchange Rate?," IMF Working Papers 03/154, International Monetary Fund.
  6. Pasaran, M.H. & Im, K.S. & Shin, Y., 1995. "Testing for Unit Roots in Heterogeneous Panels," Cambridge Working Papers in Economics 9526, Faculty of Economics, University of Cambridge.
  7. Joseph E. Gagnon, 1996. "Net foreign assets and equilibrium exchange rates: panel evidence," International Finance Discussion Papers 574, Board of Governors of the Federal Reserve System (U.S.).
  8. Ratna Sahay & Luis Felipe Céspedes & Paul Cashin, 2002. "Keynes, Cocoa, and Copper," IMF Working Papers 02/223, International Monetary Fund.
  9. Ronald MacDonald & Peter B. Clark, 1998. "Exchange Rates and Economic Fundamentals," IMF Working Papers 98/67, International Monetary Fund.
  10. Hamid Faruqee, 1995. "Long-Run Determinants of the Real Exchange Rate: A Stock-Flow Perspective," IMF Staff Papers, Palgrave Macmillan, vol. 42(1), pages 80-107, March.
  11. Mohsin S. Khan & Ehsan U. Choudhri, 2004. "Real Exchange Rates in Developing Countries," IMF Working Papers 04/188, International Monetary Fund.
  12. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  13. Mark, Nelson C. & Sul, Donggyu, 2001. "Nominal exchange rates and monetary fundamentals: Evidence from a small post-Bretton woods panel," Journal of International Economics, Elsevier, vol. 53(1), pages 29-52, February.
  14. Peter Pedroni, 1999. "Critical Values for Cointegration Tests in Heterogeneous Panels with Multiple Regressors," Department of Economics Working Papers 2000-02, Department of Economics, Williams College.
  15. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
  16. Peter Isard & Hamid Faruqee, 1998. "Exchange Rate Assessment," IMF Occasional Papers 167, International Monetary Fund.
  17. Chen, Yu-chin & Rogoff, Kenneth, 2003. "Commodity currencies," Journal of International Economics, Elsevier, vol. 60(1), pages 133-160, May.
  18. Hamid Faruqee, 1994. "Long-Run Determinants of the Real Exchange Rate," IMF Working Papers 94/90, International Monetary Fund.
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Citations

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Cited by:
  1. Tang, Hsiao Chink, 2011. "Intra-Asia Exchange Rate Volatility and Intra-Asia Trade: Evidence by Type of Goods," Working Papers on Regional Economic Integration 90, Asian Development Bank.
  2. THORBECKE, Willem, 2008. "The Effect of Exchange Rate Volatility on Fragmentation in East Asia: Evidence from the Electronics Industry," Discussion papers 08016, Research Institute of Economy, Trade and Industry (RIETI).
  3. Tamim Bayoumi & Martin Mühleisen, 2006. "Energy, the Exchange Rate, and the Economy," IMF Working Papers 06/70, International Monetary Fund.

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