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Real Exchange Rate Misalignments: Theoretical Modelling and Empirical Evidence

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  • Megumi Kubota

Abstract

The real exchange rate (RER) misalignment is a key variable in academic and policy circles. Among policy circles, sustained RER overvaluations are observed by authorities for future exchange rate adjustments. Some countries, on the other hand, have pursued very active exchange rate policies in order to undervalue their currencies to foster growth through export promotion (e.g. China). Our goal is to assess whether these policies can sustain RER undervaluation. In this context, this paper complements and improves upon the existing literature by formulating a theoretical based model to compute equilibrium real exchange rate and its misalignment and to estimate and calculate RER misalignments. One of the novelties is to derive and solve for what we call intertemporal BOP equilibrium and equilibrium in the tradable and non-tradable goods market based on the current account dynamics and Harrod-Balassa-Samuelson (HBS) productivities. With our novelty of modeling RER misalignments we estimate fundamental RER equation using cointegration techniques for time series –i.e. Johansen's (1988,1991) multivariate analysis and the error correction model (ECM) by Bewley (1979) and Wickens and Breusch (1987)– and for heterogeneous panel data –i.e. the pooled mean group estimator (PMGE) by Pesaran, Shin and Smith (1999).

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Paper provided by Department of Economics, University of York in its series Discussion Papers with number 09/24.

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Handle: RePEc:yor:yorken:09/24

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Cited by:
  1. Megumi Kubota, . "Assessing the Real Exchange Rate Misalignments: Is Real Undervaluation of the Currency Likely and Can It Be Sustained?," Discussion Papers 09/25, Department of Economics, University of York.
  2. Emerson Fernandes Marçal & Priscila Fernandes Ribeiro, 2011. "Levado pelos Fundamentos? Estimando o Desalinhamento Cambial Norte-Americano a partir de Técnicas de Cointegração," Discussion Papers 1674, Instituto de Pesquisa Econômica Aplicada - IPEA.
  3. Samuel W. Malone, 2011. "Sovereign indebtedness, default, and gambling for redemption," Oxford Economic Papers, Oxford University Press, vol. 63(2), pages 331-354, April.
  4. Irineu E. Carvalho Filho & Rudolfs Bems, 2009. "Exchange Rate Assessments," IMF Working Papers 09/281, International Monetary Fund.
  5. Calderon, Cesar & Kubota, Megumi, 2012. "Gross inflows gone wild : gross capital inflows, credit booms and crises," Policy Research Working Paper Series 6270, The World Bank.
  6. Kubota, Megumi, 2013. "Estimating the half-life of theoretically founded real exchange rate misalignments," Policy Research Working Paper Series 6411, The World Bank.
  7. Emerson Fernandes Marçal & Fernando Barbi, 2010. "“Quo Vadis Real? Estimating the Brazilian Real Exchange Rate Misalignment in Vector Error Correction Model with Structural Change”," Working Papers 10-2010, Universidade de São Paulo, Faculdade de Economia, Administração e Contabilidade de Ribeirão Preto.
  8. Marçal, Emerson Fernandes, 2013. "Exchange rate misalignments, interdependence, crises, and currency wars: an empirical assessment," Textos para discussão 348, Escola de Economia de São Paulo, Getulio Vargas Foundation (Brazil).

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