Global Imbalances: Should We Use Fundamental Equilibrium Exchange Rates?

Saadaoui, Jamel (2012): Global Imbalances: Should We Use Fundamental Equilibrium Exchange Rates?

Abstract

The reduction of global imbalances observed during the climax of crisis is incomplete. In this context, currencies realignments are still proposed to ensure global macroeconomic stability. These realignments are based on equilibrium rates derived from equilibrium exchange rate models. Among these models, we have the fundamental equilibrium exchange rate (FEER) model introduced by Williamson (1994). This approach is often labelled as normative mainly because the return to the equilibrium is not described in the model. If the FEER is not related neither in the short nor in the long to the real exchange rates, we see no clear justification to intervene in foreign exchange markets based on these equilibrium rates. In this case, the FEER is a normative approach and should not be used to reduce global imbalances. This paper provides empirical evidences robust to cross-sectional dependence that the FEER is related to real exchange rate in the long run and thus could be a useful tool to prevent the resurgence of large global imbalances and associated risks.

• Item Type: MPRA Paper
• Language: English
• Keywords: Global Imbalances; Equilibrium Exchange Rate; International Monetary Cooperation
• Subjects: F - International Economics > F3 - International Finance > F32 - Current Account Adjustment ; Short-Term Capital Movements; C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C23 - Panel Data Models ; Spatio-temporal Models; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; F - International Economics > F3 - International Finance > F31 - Foreign Exchange

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