Exchange Rate Misalignments, Interdependence, Crises, and Currency Wars: An Empirical Assessment

Abstract

This study aims to compare two different methodologies of calculating exchange rate misalignment and test whether there is interdependence among countries in determining the real effective exchange rate. Two different econometric approaches are used to achieve these goals. The first one involves estimating a multivariate time series model that contains only country-specific variables and evaluating if this basic model can be improved by adding other countries’ variables. The study uses the algorithm suggested by Hendry et al. to select the best model specification. The second strategy involves estimating long panel data with the real effective exchange rate and fundamentals for a group of countries and explicitly testing the interdependence hypothesis. The results suggest that the long-run exchange rate is mainly driven by its own fundamentals for most countries. The existence of interdependence is restricted to short-run dynamics.