Misalignment, Debt Accumulation and Fundamental Equilibrium Exchange Rates

This article deals with hysteresis in the fundamental equilibrium exchange rate (FEER) arising from misalignment. When the actual real exchange rate departs from its FEER value, current account realisations—and consequently, debt service obli gations—will differ from those assumed in the initial FEER calculation, necessitating its recomputation. The article derives a formal expression for this hysteresis effect in the FEER, and derives and applies rules of thumb for computing the hysteresis effect when considering the rate of approach of an exchange rate toward its FEER value.