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

  • Jaewoo Lee
  • Hamid Faruqee
  • Tamim Bayoumi

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
Date of creation: 01 Dec 2005
Date of revision:
Handle: RePEc:imf:imfwpa:05/229
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  1. Peter Pedroni, 1999. "Critical Values for Cointegration Tests in Heterogeneous Panels with Multiple Regressors," Department of Economics Working Papers 2000-02, Department of Economics, Williams College.
  2. Chen, Yu-chin & Rogoff, Kenneth, 2003. "Commodity currencies," Journal of International Economics, Elsevier, vol. 60(1), pages 133-160, May.
  3. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  4. Ken Froot & Kenneth Rogoff, . "Perspectives on PPP and Long-Run Real Exchange Rates," Working Paper 32027, Harvard University OpenScholar.
  5. Peter Isard & Hamid Faruqee, 1998. "Exchange Rate Assessment; Extension of the Macroeconomic Balance Approach," IMF Occasional Papers 167, International Monetary Fund.
  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.
  7. Maurice Obstfeld and Kenneth Rogoff., 2000. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," Center for International and Development Economics Research (CIDER) Working Papers C00-112, University of California at Berkeley.
  8. 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.).
  9. Nelson Mark & Donggyu Sul, 1998. "Norminal Exchange Rates and Monetary Fundamentals: Evidence from a Small Post-Bretton Woods Panel," Working Papers 98-19, Ohio State University, Department of Economics.
  10. Lane, Philip & Milesi-Ferretti, Gian Maria, . "External Wealth of Nations," Instructional Stata datasets for econometrics extwealth, Boston College Department of Economics.
  11. 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.
  12. Hamid Faruqee, 1994. "Long-Run Determinants of the Real Exchange Rate; A Stock-Flow Perspective," IMF Working Papers 94/90, International Monetary Fund.
  13. Pasaran, M.H. & Im, K.S. & Shin, Y., 1995. "Testing for Unit Roots in Heterogeneous Panels," Cambridge Working Papers in Economics 9526, Faculty of Economics, University of Cambridge.
  14. 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.
  15. Ronald MacDonald & Peter B. Clark, 1998. "Exchange Rates and Economic Fundamentals; A Methodological Comparison of Beers and Feers," IMF Working Papers 98/67, International Monetary Fund.
  16. Jaewoo Lee & Man-Keung Tang, 2003. "Does Productivity Growth Lead to Appreciation of the Real Exchange Rate?," IMF Working Papers 03/154, International Monetary Fund.
  17. Ratna Sahay & Luis Felipe Céspedes & Paul Cashin, 2002. "Keynes, Cocoa, and Copper; In Search of Commodity Currencies," IMF Working Papers 02/223, International Monetary Fund.
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