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Much Ado about the Egyptian Pound: Exchange Rate Misalignment and the Path Towards Equilibrium

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  • Noureldin Diaa

    (Department of Economics, American University in Cairo, AUC Avenue, P.O. Box 74, New Cairo11835, Egypt)

Abstract

This paper estimates Egypt's equilibrium real exchange rate and exchange rate misalignment based on economic fundamentals over the period 2001Q3–2017Q3. Focusing on the more recent period, we find that the Egyptian pound was undervalued by about 22.3% in 2017Q1 due to overshooting its equilibrium value after floating the currency in 2016Q4. The currency undervaluation then declined to 18.5% in 2017Q3 driven by an increase in the real effective exchange rate due to a surge in domestic inflation. With regard to the determinants of the equilibrium real exchange rate, we find the productivity differential (vis-à-vis Egypt's trade partners) and trade openness to be the most significant factors. We also provide projections for the equilibrium real exchange rate and exchange rate misalignment until 2020Q4, which reveal that the exchange rate undervaluation will be dissipating fast due to high inflation. If the nominal exchange rate stabilizes at its level in 2017Q3 (17.73 pounds per US dollar), the currency will be overvalued by 13.1% in 2020Q4. Given the uncertainty surrounding the projections, a forecast combination approach is also presented. Finally, the paper highlights the implications of the empirical findings for the conduct of monetary policy in Egypt.

Suggested Citation

  • Noureldin Diaa, 2018. "Much Ado about the Egyptian Pound: Exchange Rate Misalignment and the Path Towards Equilibrium," Review of Middle East Economics and Finance, De Gruyter, vol. 14(2), pages 1-19, August.
    • Handle: RePEc:bpj:rmeecf:v:14:y:2018:i:2:p:19:n:4
    DOI: 10.1515/rmeef-2018-0002
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    2. Nouran Hussein & Jasmin Fouad, 2020. "When the Art of Macroeconomic Management Confronts the Evolution of Business Cycles: Zooming into the Egyptian Case," International Journal of Business and Management, International Institute of Social and Economic Sciences, vol. 8(1), pages 11-34, May.
    3. Lemaire Thibault, 2023. "Civil Conflicts and Exchange Rate Misalignment: Evidence from MENA and Arab League Members," Review of Middle East Economics and Finance, De Gruyter, vol. 19(2), pages 101-130, August.

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    More about this item

    Keywords

    equilibrium real exchange rate; exchange rate misalignment; economic fundamentals; cointegration; structural break;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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