Agnes_Benassy-Quere

Where are key currencies going?

Agnès Bénassy-Quéré GIC-Club du CEPII-Barclays, May 13 2008

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1. Fundamentals

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A forward-looking model e t = it − it* + e ta, t + 1 − a σ E2 ( f 0 , t − ω t )

Ωt Pt Yt

ωt =

with Rational expectations:

(

)

e ta, t + 1 = E t (e t + 1 ) = E t it + 1 − it*+ 1 − a σ E2 E t ( f 0 , t + 1 − ω t + 1 )

et =

∑ E (i ∞

k =0

t

t+k

−i

)− a σ ∑ E ( f ∞

* t+k

Monetary policy

2 E

k =0

t

0 ,t + k

− ω t + k ) + E t et + ∞

Portfolio choices, foreign imbalances

Long term

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Monetary policy: euro/dollar

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Other factors: euro/dollar

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2. Equilibrium exchange rates

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What equilibrium?

Our focus

Market equilibrium

Internal and external balance (FEER)

Stable NFA (BEER, NATREX‌)

Short run

Medium run

Long run

Sticky prices

Flexible prices

Flexible prices

Flexible prices

Noise and bubbles

Stock/flow adjustment under way

Stock/flow adjustment achieved

Stock/flow adjustment achieved

Productivity given

Productivity catch up under way

Productivity catch up achieved

Purchasing power parity

Very long run

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Equilibrium net foreign asset positions

1980-2005 15 countries or zones (ÂŤ G20 Âť): Euro area, Japan, United States, UK, Australia, Canada, Korea, Argentina, Brazil, Mexico China, India, Indonesia, Turkey, South Africa

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Observed and « equilibrium » NFA, 1980-2005

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Observed and « equilibrium » NFA, 2005

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Two concepts of equilibrium Estimated equation: Q = f(NFA, TOT, PROD) → BEER*: predicted Q with equilibrium NFA → FEER**: Q consistent with NFA converging to equilibrium in T years

BEER FEER Status quo

*

BEER for Behavioural Equilibrium Exchange Rate. (MacDonald, 1997; Clark&MacDonald, 1998).

** FEER for Fundamental Equilibrium Exchange Rate (Williamson, 1984).

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Current account targets, 2005 Underlying Targets* Current account CA 1 CA 2 CA 3 Canada 0.1 1.1 -2.1 -0.8 Euro area -1.4 -0.2 1.4 4.5 Japan 4.3 1.1 -6.0 -4.3 UK -1.6 -2.6 2.6 8 .1 USA -5.9 -3.0 2.7 -0.7 Argentina 5.3 -1.5 2.4 3.8 Australia -6.9 -2.2 2.1 3.1 Brazil 0.1 -1.5 1.0 1.4 China 10.0 2.6 -6.2 -5.6 India -1.3 -0.7 -3.7 -8.8 Indonesia 2.0 -0.7 -3.6 1.7 Korea -1.0 -0.5 -2.7 -2.1 Mexico -1.2 -1.5 0.5 0.8 South Africa -3.0 -1.5 -1.7 -0.9 Turkey -4.6 -2.2 -1.4 -1.1 * CA 1: Williamson (2006) for USA. Canada. Japan. euro area. UK. Korea and China; IMF (2006) for other countries. CA 2: current account that would make the NFA converge to its equilibrium level in 5 years. CA 3: idem CA 2 with 20% krash in US asset prices.

Source: Bénassy-Quéré et al. (2008).

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Real effective misalignments in 2005 (+ = undervalued)

BEER FEER 1 FEER 2 FEER 3 FEER 2’ Canada 5.8 -4.1 9.1 3.7 2.7 Euro area -4.7 -9.3 -21.8 -46.9 -6.3 Japan 2.1 33.4 108.0 89.8 31.7 UK -12.1 6.0 -25.2 -58.3 -6.6 USA -2.1 -48.5 -142.9 -86.2 -30.6 Argentina 63.3 89.7 38.5 19.4 8.5 Australia 1.4 -40.1 -76.9 -85.4 -20.5 Brazil -27.1 30.6 -18.5 -25.0 -4.2 China 22.3 73.9 161.7 156.2 31.1 India 5.9 -36.2 152.4 47.3 29.0 Indonesia 10.1 30.4 63.3 3.5 11.6 Korea -15.9 -5.4 16.7 10.1 2.8 Mexico -14.2 -43.9 -27.6 -32.1 -3.8 South Africa 2.0 -22.4 -19.9 -31.9 -3.0 Turkey 0.5 -52.9 -70.5 -77.2 -7.6 Note: a positive sign refers to an under-valued currency compared to equilibrium.

Source: Bénassy-Quéré et al. (2008).

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Bilateral euro/dollar misalignment at end 2007

Misalignment in 2005 (%)

BEER FEER 1 FEER 2 FEER 3 FEER 2’

RER variation 2005-2007(%)

Misalignment in 2007 (%)

EUR/USD dec. 2007

Equilibrium exchange rate EUR/USD dec. 2007 -5.9 -14.8 -20.7 1 .45 1.15 25.0 -14.8 10.2 1 .45 1.60 67.9 -14.8 53.1 1 .45 2.22 13.3 -14.8 -1.5 1 .45 1.43 14.8 -14.8 -2.2 1 .45 1.42 Note: a negative sign point to the euro being over-valued against the USD. Source: Bénassy-Quéré et al. (2008).

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