Estimates of Fundamental Equilibrium Exchange Rates, May 2013

In this semiannual update, William R. Cline presents new estimates of fundamental equilibrium exchange rates (FEERs). Once again it is found that the key cases of the United States and China involve only modest over- and undervaluation, respectively. However, the Japanese yen is found to have fallen substantially below its FEER as a consequence of the aggressive quantitative easing policy, and Cline suggests that if the currency continues much further along a downward path, the G-7 may need to consider joint intervention to curb its decline. The study concludes by adding a variant of the calculations in which rich countries are set a floor target of at least a zero current account balance, and emerging market economies are set a ceiling target of zero balance. In this "aggressive rebalancing" in which capital would no longer flow "uphill" from poor to rich countries, the US dollar would require a much larger depreciation and the Chinese renminbi a much larger appreciation.