Measuring currency pressures: The cases of the Japanese yen, the Chinese yuan, and the UK pound

We investigate bilateral currency pressures against the US dollar for three currencies: the Japanese yen, the Chinese yuan, and the UK pound during the period 2000:Q1 to 2009:Q4. We employ a model-based methodology to measure exchange market pressure over the period. Conversion factors required to estimate the pressure on these currencies are computed using a time-varying coefficient regression. We then use our measures of currency pressures to assess deviations of exchange rates from their market-equilibrium levels. For the yen, our measure of currency pressure suggests undervaluation during the initial part of our estimation period, a period during which the Bank of Japan sold yen in the foreign exchange market. We find persistent undervaluation of the yuan throughout the estimation period, with the undervaluation peaking at about 20% in 2004 and 2007. For the pound, the results indicate low pressure – suggesting a mainly free-floating currency – throughout the sample period. These results appear consistent with the policies pursued by the central banks of the currencies in question.