How to disentangle exchange rate misalignment using a Global approach and economic identifying restrictions

Abstract

Exchange rates are important macroeconomic prices and changes in these rates affect economic activ- ity, prices, interest rates, and trade flows. Methodologies have been developed in empirical exchange rate misalignment studies to evaluate whether a real effective exchange is overvalued or undervalued. There is a vast body of literature on the determinants of long-term real exchange rates and on empirical strategies to implement the equilibrium norms obtained from theoretical models. This study seeks to contribute to this literature by showing that the global vector autoregressions model (GVAR) proposed by Pesaran and co-authors can add relevant information to the literature on measuring exchange rate misalignment. With the GVAR methodology, we show that it is possible to detach the misalignment of a country in two factors.