Single-equation estimation of the equilibrium real exchange rate

Estimating the degree of exchange-rate misalignment remains one of the most challenging empirical problems in an open economy. The basic problem is that the value of the real exchange rate is not observable. Standard theory tells us, however, that the equilibrium real exchange rate is a function of observable macroeconomic variables and that the actual real exchange rate approaches the equilibrium rate over time. A recent strand of the empirical literature exploits these observations to develop a single-equation approach to estimating the equilibrium real exchange rate. Drawing on that earlier work, the authors outline an econometric methodology for estimating both the equilibrium real exchange rate and the degree of exchange-rate misalignment. They illustrate the methodology using annual data from Cote d'Ivoire and Burkina Faso.