Single-Equation Estimation of the Equilibrium Real Exchange Rate

Abstract

ABSTRACT: Estimating the degree of exchange rate misalignment remains one of the most challenging empirical problems in open-economy. A fundamental difficulty is that the equilibrium value of the real exchange rate is not observable. Standard theory tells us, however, that the equilibrium real exchange rate is a function of observable macroeconomic variables, and that the actual real exchange rate approaches the equilibrium rate over time. A recent strand of the empirical literature exploits these observations to develop a single-equation approach to estimating the equilibrium real exchange rate. Drawing on this earlier work, we outline an econometric methodology for estimating both the equilibrium real exchange rate and the degree of misalignment and illustrate the methodology using annual data from Côte d'Ivoire and Burkina Faso. We are grateful to Chris Adam, Neil Ericsson, Philip Jefferson, and Luis Serven for helpful advice, to Peter Montiel for very thorough comments on an earlier draft, and to Ingrid Ivins for assistance with data. Larry Hinkle provided invaluable comments and advice throughout and constructed the counterfactual simulations for Côte d'Ivoire and Burkina Faso. All errors are our own responsibility. Contents 1.