>2009 Estimates of Fundamental Equilibrium Exchange Rates

When we first published our estimates of fundamental equilibrium exchange rates (FEERs) in July 2008 (Cline and Williamson 2008), we stated that this was intended to be a regular series
of publications. This policy brief updates those estimates in light of the momentous changes in the world economy during the past year. Many of those changes, notably changes in actual exchange rates, should not influence FEERs, except insofar as we allow a range of variation of the target current account balance. But equally clearly, one does expect some of the changes, notably forecasts of the prices of oil and other commodities, to be important determinants of equilibrium exchange rates.

A major consequence of the global financial crisis has been a further rise in the already overvalued dollar, as investors have turned to the United States as a relatively safe haven. A larger overvaluation implies a larger external deficit, after the two-year or so lag from the exchange rate signal to trade flows. Similarly, the rise in perceived risk combined with the reduction in high domestic interest rates in some countries for counter cyclical purposes has ended the “carry trade” and contributed to a strengthening of the yen in particular, reversing the currency’s gap from its previous estimated FEER, from a significant trade-weighted overvaluation in 2008 to a small undervaluation today.2 The extreme and unusually synchronized global recession has also caused major reductions in oil and commodity
prices, a second potentially important cause of changes in FEERs. Finally, the most severe postwar global recession may have changed investors’ perceptions of long-term relative growth
prospects across countries, although it is too early to judge this definitively.

To see full report: EXCHANGE RATES