Assessing Real Exchange Rate Misalignments
There is a renewed debate on the role of exchange rate policies as an industrial policy tool in both academic and policy circles. Policy practitioners usually examine real exchange rate misalignments to monitor the behavior of this key relative pri...
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| Format: | Policy Research Working Paper |
| Language: | English |
| Published: |
2012
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| Subjects: | |
| Online Access: | http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20111229162948 http://hdl.handle.net/10986/3694 |
| Summary: | There is a renewed debate on the role of
exchange rate policies as an industrial policy tool in both
academic and policy circles. Policy practitioners usually
examine real exchange rate misalignments to monitor the
behavior of this key relative price and, if possible,
exploit distortions in the traded and non-traded relative
price to promote growth. Anecdotal evidence shows that some
countries have pursued very active exchange rate policies to
promote the export sector and enhance growth by undervaluing
their currencies. The main goal of this paper is to provide
a systematic characterization of real exchange rate
undervaluations. The long-run real exchange rate equation is
estimated using: (a) Johansen time series cointegration
estimates, and (b) pooled mean group estimates for
non-stationary panel data. The paper constructs a dataset of
real undervaluation episodes. It first evaluates whether
(and if so, to what extent) economic policies can be used to
either cause or sustain real undervaluations. In this
context the paper empirically models the likelihood and
magnitude of sustaining real exchange rate undervaluations
by examining their link to policy instruments (such as
exchange rate regimes and capital controls, among other
policies) using probit and Tobit models. Finally, it
investigates whether foreign exchange intervention can
generate persistent real exchange rate deviations from
equilibrium. In general, it finds that intervention can lead
to greater persistence in the incidence and magnitude of
real exchange rate undervaluations. |
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