Examining measures of the equilibrium Real Exchange Rate: Macroeconomic Balance and the Natural Real Exchange Rate Approaches

This paper examines two measures of the equilibrium real exchange rate using the Macroeconomic Balance (MB) and the Natural Real Exchange Rate (NATREX) approaches. Unlike previous studies, this study controls for business cycle effects and the debt sustainability position of countries on the current account, while providing a more comprehensive measure of relative productivity. A longitudinal panel econometric technique is utilized on a set of countries from the Western Hemisphere. These countries operate a managed float exchange rate system; have similar output per capita and equivalent levels of openness. The findings suggest that there were several intervals of exchange rate misalignment for each country, including Jamaica, over the 1990-2010 study period. The exchange rate misalignment series was found to be stationary which is an indication that there is a long-run equilibrium mean and a constant variance for exchange rate misalignment. This long-run misalignment mean is assumed to be zero by economic theory. The Autoregressive Distributive Lag (ARDL) error correction model suggests that disequilibrium in the exchange rate is adjusted by 46.2 per cent each year and the half-life deviation formula suggests that a half of the deviation in the exchange rate is corrected after 1.1 years for each country in the panel.