Modelling the Long-Run Real Effective Exchange Rate of the New Zealand Dollar

Abstract

The usefulness of the concept of an equilibrium exchange rate has been brought into sharp focus by the dramatic depreciation of the euro since its inception in 1999. Does this movement reflect a movement of the actual exchange rate relative to its equilibrium or has the equilibrium shifted relative to the perception of where the euro was in 1999? Similar kinds of questions have been asked about the behaviour of the New Zealand dollar since the latter part of 1999. To answer these kinds of questions it is necessary to have some measure of an equilibrium exchange rate and there are a plethora of alternative approaches available in the literature. In this paper we use the behavioural equilibrium exchange rate (BEER) approach of Clark and MacDonald (1999) to produce long-run equilibrium exchange rates for the effective real exchange rates of the New Zealand dollar. We demonstrate that a well founded measure of the equilibrium value of the dollar may be recovered from a relatively small set of fundamental variables and that this can be used to produce an assessment of the dollar in terms of periods of misalignment.

JEL Classification: F31