Methodological Advances in the Assessment of Equilibrium Exchange Rates

88 Pages Posted: 9 Feb 2010

See all articles by Matthieu Bussière

Matthieu Bussière

Banque de France

Michele Ca' Zorzi

European Central Bank (ECB)

Alexander Chudik

Federal Reserve Banks - Federal Reserve Bank of Dallas

Alistair Dieppe

World Bank

Date Written: January 29, 2010

Abstract

This paper reviews three different concepts of equilibrium exchange rates that are widely used in policy analysis and constitute the backbone of the IMF CGER assessment: the Macroeconomic Balance, the External Sustainability and the reduced form approaches. We raise a number of econometric issues that were previously neglected, proposing some methodological advances to address them. The first issue relates to the presence of model uncertainty in deriving benchmarks for the current account, introducing Bayesian averaging techniques as a solution. The second issue reveals that, if one considers all the sets of plausible identification schemes, the uncertainty surrounding export and import exchange rate elasticities is large even at longer horizons. The third issue discusses the uncertainty associated to the estimation of a reduced form relationship for the real exchange rate, concluding that inference can be improved by panel estimation. The fourth and final issue addresses the presence of strong and weak cross section dependence in panel estimation, suggesting which panel estimators one could use in this case. Overall, the analysis puts forward a number of innovative solutions in dealing with the large uncertainties surrounding equilibrium exchange rate estimates.

Keywords: Equilibrium exchange rates, IMF CGER methodologies, current account, trade elasticities, global imbalances

JEL Classification: F31, F32, F41

Suggested Citation

Bussiere, Matthieu and Ca' Zorzi, Michele and Chudik, Alexander and Dieppe, Alistair, Methodological Advances in the Assessment of Equilibrium Exchange Rates (January 29, 2010). ECB Working Paper No. 1151. Available at SSRN: https://ssrn.com/abstract=1536018

Matthieu Bussiere

Banque de France ( email )

Paris
France

Michele Ca' Zorzi (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Alexander Chudik

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

Alistair Dieppe

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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