Before the Fall, Was the Turkish Lira Overvalued?

Abstract

This article examines the validity of purchasing power parity in evaluating whether the Turkish lira was overvalued on the eve of the 2001 crises. Univariate and multivariate time series techniques are used to test whether the real exchange rate is mean reverting. Half-life of deviation from purchasing power parity for various definitions is derived. The Johansen cointegration test is applied to bilateral exchange rates using the consumer price index (CPI) and the wholesale price index (WPI). Finally, various measures of misalignments are calculated, and evidence is provided that calculated half-lives are, in general, short compared to low inflation countries. Furthermore, the data support long-run relationships among exchange rates, domestic prices, and foreign prices. Calculated misalignments give mixed results on bilateral exchange rates based on CPI and WPI. While the WPI-based bilateral real exchange rate gives undervaluation, the CPI-based bilateral real exchange rate and trade-weighted real exchange rates based on WPI reveal that Turkish lira was overvalued before the eve of 2001 crises.