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A real differential view of equilibrium real exchange rates and misalignments

Author

Listed:
  • Hoffmann, Mathias
  • MacDonald, Ronald

Abstract

This paper examines the interaction of G7 real exchange rates with real output and interest rate differentials. Using cointegration methods, we generally find a link between the real exchange rate and the real interest differential. This finding contrasts with the majority of the extant research on the real exchange rate - real interest rate link. We identify a new measure of the equilibrium exchange rate in terms of the permanent component of the real exchange rate that is consistent with the dynamic equilibrium given by the cointegration relation. Furthermore, the presence of cointegration also allows us to identify real, nominal and transitory disturbances with only minimal identifying restrictions. Our findings suggest that persistent deviations of real exchange rates from their equilibrium value can have feedback effects on the underlying fundamentals, hence altering the equilibrium exchange rate itself. This has important implications for the persistence measures of real exchange rates that are reported elsewhere in the literature.

Suggested Citation

  • Hoffmann, Mathias & MacDonald, Ronald, 2000. "A real differential view of equilibrium real exchange rates and misalignments," CFS Working Paper Series 2000/08, Center for Financial Studies (CFS).
    • Handle: RePEc:zbw:cfswop:200008
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    Citations

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    Cited by:

    1. Nikolaos Giannellis & Athanasios Papadopoulos, 2007. "Estimating the Equilibrium Effective Exchange Rate for Potential EMU Members," Open Economies Review, Springer, vol. 18(3), pages 307-326, July.
    2. Gloria Alonso & Juan Nicolás Hernandez & José David Pulido & Martha Lucía Villa, 2008. "Medidas alternativas de tasa de cambio real para Colombia," Borradores de Economia 514, Banco de la Republica de Colombia.
    3. Francisco Maeso–Fernandez & Chiara Osbat & Bernd Schnatz, 2002. "Determinants of the Euro Real Effective Exchange Rate: A BEER/PEER Approach," Australian Economic Papers, Wiley Blackwell, vol. 41(4), pages 437-461, December.
    4. Shehu Usman Rano, Aliyu, 2007. "Real Exchange Rate Misalignment: An Application of Behavioral Equilibrium Exchange Rate (BEER) to Nigeria," MPRA Paper 10376, University Library of Munich, Germany.
    5. Ronald MacDonald, 2000. "The role of the exchange rate in economic growth: a euro-zone perspective," Working Paper Research 09, National Bank of Belgium.

    More about this item

    Keywords

    Equilibrium Exchange Rates; Cointegration; Permanent and Transitory Decomposition;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange

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