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

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Author Info
Tamim Bayoumi
Hamid Faruqee
Jaewoo Lee

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

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Length: 28 pages
Date of creation: 21 Dec 2005
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Handle: RePEc:imf:imfwpa:05/229

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Keywords: Exchange rates ; Economic models ;

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Mohsin S. Khan & Ehsan U. Choudhri, 2004. "Real Exchange Rates in Developing Countries: Are Balassa-Samuelson Effects Present?," IMF Working Papers 04/188, International Monetary Fund. [Downloadable!]
  2. Maurice Obstfeld & Kenneth Rogoff, 2000. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Working Papers 7777, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Hamid Faruqee & Peter Isard, 1998. "Exchange Rate Assessment: Extension of the Macroeconomic Balance Approach," IMF Occasional Papers 167, International Monetary Fund.
  4. Lane, Philip & Milesi-Ferretti, Gian Maria, . "External Wealth of Nations," Instructional Stata datasets for econometrics extwealth, Boston College Department of Economics. [Downloadable!]
  5. 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. [Downloadable!] (restricted)
  6. 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. [Downloadable!] (restricted)
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  7. Pedroni, Peter, 1999. " Critical Values for Cointegration Tests in Heterogeneous Panels with Multiple Regressors," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 61(0), pages 653-70, Special I. [Downloadable!] (restricted)
  8. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June. [Downloadable!] (restricted)
  9. Peter B. Clark & Ronald MacDonald, 1998. "Exchange Rates and Economic Fundamentals - A Methodological Comparison of BEERs and FEERs," IMF Working Papers 98/67, International Monetary Fund.
  10. Luis Felipe Céspedes & Paul Cashin & Ratna Sahay, 2003. "Keynes, Cocoa, and Copper: In Search of Commodity Currencies," IMF Working Papers 02/223, International Monetary Fund.
  11. Froot, Kenneth A. & Rogoff, Kenneth, 1995. "Perspectives on PPP and long-run real exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 32, pages 1647-1688 Elsevier. [Downloadable!] (restricted)
  12. Chen, Yu-chin & Rogoff, Kenneth, 2003. "Commodity currencies," Journal of International Economics, Elsevier, vol. 60(1), pages 133-160, May. [Downloadable!] (restricted)
  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. [Downloadable!] (restricted)
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  14. Hamid Faruqee, 1994. "Long-Run Determinants of the Real Exchange Rate - A Stock-Flow Perspective," IMF Working Papers 94/90, International Monetary Fund.
  15. 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.). [Downloadable!]
  16. Man-Keung Tang & Jaewoo Lee, 2003. "Does Productivity Growth Lead to Appreciation of the Real Exchange Rate?," IMF Working Papers 03/154, International Monetary Fund. [Downloadable!]
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  1. Tamim Bayoumi & Martin M�hleisen, 2006. "Energy, the Exchange Rate, and the Economy: Macroeconomic Benefits of Canada's Oil Sands Production," IMF Working Papers 06/70, International Monetary Fund. [Downloadable!]
  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). [Downloadable!]
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