Misalignment Under Different Exchange Rate Regimes: the Case of Turkey

The paper examines misalignment of the Turkish lira between 1998 and 2011. We first estimate the equilibrium real exchange rate for Turkey, then compute misalignment and finally test for structural breaks in the misalignment series. Through our tests we find three structural regimes. Our results show that the lira was considerably overvalued in the first regime, which is when Turkey had a fixed exchange rate regime. This was not the case for the periods that had a floating exchange rate. Thus, we confirm that overvalued currencies that have been linked to financial crises are a more serious concern for fixed exchange rate regimes. More importantly, we find that volatility which is a bigger concern in floating regimes is a significant problem for Turkey in the last few years. In fact, the recent dangerously large and rising current account deficits may be a result of volatility rather than overvaluation.