Abstract
Abstract Exchange rates are important macroeconomic prices and changes in these rates affect economic activity, prices, interest rates, and trade flows. Methodologies have been developed in empirical exchange rate misalignment studies to evaluate whether a real effective exchange is overvalued or undervalued. There is a vast body of literature on the determinants of long-term real exchange rates and on empirical strategies to implement the equilibrium norms obtained from theoretical models. This study seeks to contribute to this literature by showing that the global vector autoregressions model (GVAR) proposed by Pesaran and co-authors can add relevant information to the literature on measuring exchange rate misalignment. Our empirical exercise suggests that the estimative exchange rate misalignment obtained from GVAR can be quite different to that using the traditional cointegrated time series techniques, which treat countries as detached entities. The differences between the two approaches are more pronounced for small and developing countries. Our results also suggest a strong interdependence among eurozone countries, as expected.
Highlights
The exchange rate is an important macroeconomic price and changes in these rates affect economic activity, prices, interest rates, and trade flows
Our results suggest that the global vector autoregressions model (GVAR) approach is worth considering. section 5 applies the limits and the merits of the GVAR approach to the exchange rate misalignment problem and suggests possible extensions to our work
The foreign trade figures were collected from the International Monetary Fund (IMF) Direction of Trade Statistics (DOTS-IMF)
Summary
The exchange rate is an important macroeconomic price and changes in these rates affect economic activity, prices, interest rates, and trade flows. The second level of debate revolves around the best empirical strategy to measure exchange rate equilibrium norms. Hossfeld (2010) reviews exchange rate misalignment literature, and evaluates the benefits and limits of the time series and panel approaches.
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