Methodological Advances in the Assessment of Equilibrium Exchange Rates
88 Pages Posted: 9 Feb 2010
Date Written: January 29, 2010
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: Suggested Citation