Global Equilibrium Exchange Rates: Euro, Dollar, 'Ins,' 'Outs,' and Other Major Currencies in a Panel Cointegration Framework

Angel J. Ubide, Enrique Alberola, Humberto Lopez, Susana G. Cervero
1999 Social Science Research Network  
This paper presents a methodology for the calculation of bilateral equilibrium exchange rates for a panel of currencies in a way that guarantees consistency at the global level. A theoretical model, which encompasses the balance of payments and the Balassa-Samuelson approaches to real exchange rate determination, shows that the stock of net foreign assets and the evolution of sectoral prices are the fundamentals underlying the behavior of the real exchange rate. An unobserved components
more » ... components methodology in a cointegration framework allows us to identify a time-varying equilibrium real exchange rate, and deviations from this equilibrium provide an estimate of the degree of multilateral misalignment. Finally, an algebraic transformation converts these multilateral equilibrium real rates into bilateral equilibrium nominal rates. The results uncover, inter alia, that by the start of Stage III of EMU the euro was significantly undervalued against the dollar and even more against the pound, but overvalued relative to the yen. Regarding EMU currencies, it is shown that the four major EMU currencies locked their parities with the euro at a rate close to equilibrium.
doi:10.2139/ssrn.199030 fatcat:oivlgidlhjel7l5tyfgy2yhd2i