November 11, 2011
Washington—The latest semiannual estimates of fundamental equilibrium exchange rates (FEERs) by Peterson Institute researchers William R. Cline and John Williamson estimate that the dollar remains overvalued by about 9 percent.1 Modest appreciation of the renminbi against the dollar, combined with higher inflation in China than in the United States, has narrowed the undervaluation of the Chinese currency from 16 percent in April to 11 percent in late October. However, the bilateral undervaluation of the renminbi against the dollar still amounts to 24 percent; this is the rise in the renminbi that would be required to achieve multilateral equilibrium if all currencies were to move to their FEERs.
For the overall US exchange rate, the rise of the renminbi has been offset by the decline in the currencies of two large US trade partners: Mexico has moved from equilibrium to a 13 percent undervaluation and Canada from equilibrium to a 4 percent undervaluation.
|The new estimates indicate the following major disequilibria (minus sign, undervalued; plus sign, overvalued):|
In the important case of the euro, by late October at $1.41 the currency was approximately at equilibrium (although it would need to appreciate by 6 percent bilaterally against the dollar if all currencies moved to their FEERs). A key implication is that steep depreciation of the euro in an attempt to boost European growth would be destabilizing globally; it would move the euro area into major undervaluation and provoke even greater dollar overvaluation. A special examination of imbalances within the euro area shows that both Greece and Portugal might need to depreciate in real effective terms by 20–25 percent to cut back their current account deficits of more than 8 percent of GDP (2011), although in an alternative diagnosis they might not need real depreciation if the International Monetary Fund’s forecast of current account equilibrium for both by 2016 is valid. "Internal devaluation" through wage curbs and greater labor flexibility, plus fiscal devaluation through a shift from payroll taxes to VAT revenue that can be rebated for exports (as in the Portuguese program), could be important measures to help assure external equilibrium with growth. Statistical tests confirm that for euro area economies under stress, however, the greater influence on government bond spreads stems from public debt levels rather than current account imbalances.
Other key findings of the new analysis include:
About the Peterson Institute
The Peter G. Peterson Institute for International Economics is a private, nonprofit, nonpartisan research institution devoted to the study of international economic policy. Since 1981 the Institute has provided timely and objective analysis of, and concrete solutions to, a wide range of international economic problems. It is one of the very few economics think tanks that are widely regarded as "nonpartisan" by the press and "neutral" by the US Congress, its research staff is cited by the quality media more than that of any other such institution. Support is provided by a wide range of charitable foundations, private corporations and individual donors, and from earnings on the Institute’s publications and capital fund. It moved into its award-winning new building in 2001, and celebrated its 25th anniversary in 2006 and adopted its new name at that time, having previously been the Institute for International Economics.
1. The Current Currency Situation. Policy Brief 11-18, November, 2011. The fundamental equilibrium exchange rate is the level that would limit the country’s current account imbalance to +/- 3 percent of GDP (except for oil-exporting countries).
2. If all currencies were to realign to their FEERs.