Exchange Rate Misalignments and Crises

The problem is to evaluate the likelihood that a country will face a currency or balance of payments crisis over a given horizon. When is it rational for market participants to expect a depreciation of the currency? On the basis of considerable empirical studies we know that in both banking and currency crises, there is a multitude of weak and deteriorating economic fundamentals. Our theme is that there is an economic logic to medium and longer-term movements in exchange rates, within the context of a consistent dynamic stock-flow model. The equilibrium real exchange rate is a trajectory, not a point. We provide objective measures of the real fundamentals that determine the moving equilibrium real exchange rate, and explain the dynamic economic mechanism whereby the actual exchange rate converges to this moving equilibrium exchange rate, called the NATREX. The fundamentals are primarily social consumption/GDP, which is generally driven by fiscal policy, and the productivity of the economy. Trends in social consumption/GDP, and in fiscal policy, reflected political regime changes in France, Germany and Italy