WORKING PAPER 08-6

Estimating Consistent Fundamental Equilibrium Exchange Rates

by William R. Cline, Peterson Institute for International Economics

July 2008

Bill CLineThis paper develops a new symmetric matrix inversion method for estimating consistent fundamental equilibrium exchange rates (FEERs) for leading advanced and emerging-market economies. It is symmetric in that it gives equal weight to the current account adjustment targets of all economies considered. The method involves first identifying desired changes in current account balances, then arriving at a set of parameters for the response of current account balances to real effective exchange rate changes. With the current account target and exchange rate response parameter in hand for each country (or region), it is possible to directly calculate the change in effective exchange rate needed to obtain the target change in current account. Matrix inversion is then used to identify a set of changes in bilateral exchange rates against the dollar that will generate a set of changes in multilateral (trade-weighted) effective exchange rates that is as close as possible to the targets desired.

The numerical estimates here draw on the International Monetary Fund's April 2008 World Economic Outlook forecasts of baseline current accounts and apply normative current account targets suggested in Policy Brief 08-7 by Cline and John Williamson as the basis for calculating the needed changes in exchange rates. The policy brief further discusses the grounds for identifying the target current account balances, adds two variants to the current account adjustment targets considered, and examines the policy implications of the results.

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RELATED LINKS

Policy Brief 14-16: Estimates of Fundamental Equilibrium Exchange Rates, May 2014 May 2014

Policy Brief 14-17: Alternatives to Currency Manipulation: What Switzerland, Singapore, and Hong Kong Can Do June 2014

Policy Brief 13-28: Stabilizing Properties of Flexible Exchange Rates: Evidence from the Global Financial Crisis November 2013

Op-ed: Unconventional Monetary Policy: Don't Shoot the Messenger November 14, 2013

Op-ed: Misconceptions About Fed's Bond Buying September 2, 2013

Working Paper 13-2: The Elephant Hiding in the Room: Currency Intervention and Trade Imbalances March 2013

Policy Brief 12-25: Currency Manipulation, the US Economy, and the Global Economic Order December 2012

Working Paper 12-19: The Renminbi Bloc Is Here: Asia Down, Rest of the World to Go? October 2012
Revised August 2013

Policy Brief 12-7: Projecting China's Current Account Surplus April 2012

Working Paper 12-4: Spillover Effects of Exchange Rates: A Study of the Renminbi March 2012

Book: Flexible Exchange Rates for a Stable World Economy October 2011

Policy Brief 10-24: The Central Banker's Case for Doing More October 2010

Policy Brief 10-26: Currency Wars? November 2010

Book: Debating China's Exchange Rate Policy April 2008



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