A Fair Exchange?: Theory and Practice of Calculating Equilibrium Exchange Rates

28 Pages Posted: 3 Mar 2006

See all articles by Tamim Bayoumi

Tamim Bayoumi

International Monetary Fund (IMF); Centre for Economic Policy Research (CEPR)

Hamid Faruqee

International Monetary Fund (IMF) - Research Department

Jaewoo Lee

International Monetary Fund (IMF) - Research Department

Date Written: December 2005

Abstract

We develop a theory-based model of equilibrium exchange rates incorporating factors that have been found to matter empirically. The model provides insights into how variables should be measured and what are appropriate cross-country restrictions. We estimate this model using a panel of 12 industrial countries. The model fits the data relatively well, implying relatively fast adjustment to equilibrium and outperforming a random walk at longer horizons. Furthermore, we find that the rate of adjustment depends on the distance from equilibrium, suggesting that part of the explanation for slow adjustment is inaccurate measures of equilibrium.

Keywords: Exchange rates, imperfect substitutability, nonlinear convergence

JEL Classification: F31, F41

Suggested Citation

Bayoumi, Tamim and Faruqee, Hamid and Lee, Jaewoo, A Fair Exchange?: Theory and Practice of Calculating Equilibrium Exchange Rates (December 2005). IMF Working Paper, Vol. , pp. 1-28, 2005. Available at SSRN: https://ssrn.com/abstract=888098

Tamim Bayoumi (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-6333 (Phone)
202-623-4795 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Hamid Faruqee

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

Jaewoo Lee

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-7331 (Phone)
202-623-6334 (Fax)

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