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A New Method of Estimating Equilibrium Real Exchange Rate in Developing Countries

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  • Renhong Wu

Abstract

How to assess the misalignments of real exchange rate in developing countries has been a difficult and unresolved issue. Over the decades, researchers have not found desirable methods to estimate the ¡°Equilibrium Exchange Rate¡±. The Purchasing Power Parity (PPP) approach has limitations, and the fixed or managed floating exchange rate regimes in developing countries make the estimating more difficult. The purpose of this paper is to discuss the limitations of the Macroeconomic Balance approach and the existing PPP approach for estimating equilibrium exchange rate in developing countries, and introduce a new method¨Cthe Adjusted PPP method to assess exchange rate in developing countries. The new method includes the Human Development Index (HDI) to adjust the traditional PPP estimates. By introducing the adjustments of HDI, the big quality differences in non-tradable goods and services between developed and developing countries are adjusted for the exchange rate estimates. Also, as a case study, the paper estimated the exchange rate in China of 1991-2013.

Suggested Citation

  • Renhong Wu, 2016. "A New Method of Estimating Equilibrium Real Exchange Rate in Developing Countries," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 8(3), pages 171-177, March.
  • Handle: RePEc:ibn:ijefaa:v:8:y:2016:i:3:p:171-177
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    References listed on IDEAS

    as
    1. Dornbusch, Rudiger, 1989. " Real Exchange Rates and Macroeconomics: A Selective Survey," Scandinavian Journal of Economics, Wiley Blackwell, vol. 91(2), pages 401-432.
    2. Engel, Charles, 2000. "Long-run PPP may not hold after all," Journal of International Economics, Elsevier, vol. 51(2), pages 243-273, August.
    3. William R. Cline & John Williamson, 2010. "Estimates of Fundamental Equilibrium Exchange Rates, May 2010," Policy Briefs PB10-15, Peterson Institute for International Economics.
    4. Ronald MacDonald & Luca Ricci, 2001. "PPP and the Balassa Samuelson Effect: the Role of the Distribution Sector," CESifo Working Paper Series 442, CESifo Group Munich.
    5. 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.
    6. Peter Isard, 2007. "Equilibrium Exchange Rates; Assessment Methodologies," IMF Working Papers 07/296, International Monetary Fund.
    7. Jaewoo Lee & Jonathan David Ostry & Alessandro Prati & Luca A Ricci & Gian M Milesi-Ferretti, 2008. "Exchange Rate Assessments; CGER Methodologies," IMF Occasional Papers 261, International Monetary Fund.
    8. Rebecca L Driver & Peter F Westaway, 2005. "Concepts of equilibrium exchange rates," Bank of England working papers 248, Bank of England.
    9. repec:pri:rpdevs:understanding_ppps_complete_with_abstract_14nov08.pdf is not listed on IDEAS
    10. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, vol. 72, pages 584-584.
    11. William R. Cline, 2015. "Estimates of Fundamental Equilibrium Exchange Rates, November 2015," Policy Briefs PB15-20, Peterson Institute for International Economics.
    12. William R. Cline, 2015. "Estimates of Fundamental Equilibrium Exchange Rates, May 2015," Policy Briefs PB15-8, Peterson Institute for International Economics.
    13. Angus Deaton & Alan Heston, 2010. "Understanding PPPs and PPP-Based National Accounts," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(4), pages 1-35, October.
    14. repec:pri:rpdevs:understanding_ppps_complete_with_abstract_14nov08 is not listed on IDEAS
    15. Peter Isard & Hamid Faruqee, 1998. "Exchange Rate Assessment; Extension of the Macroeconomic Balance Approach," IMF Occasional Papers 167, International Monetary Fund.
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    More about this item

    Keywords

    exchange rate; macroeconomic balance approach; PPP; adjusted PPP; HDI;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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