Before the Fall

📖 The Scoop

I implement two major approaches to identifying the equilibrium exchange rate. First, the concept of purchasing power parity is tested and used to define the equilibrium real exchange rate for the Indonesian rupiah, Korean won, Malaysian ringgit, Philippine peso, Singapore dollar, Taiwanese dollar and the Thai baht. The calculated PPP rates are then used to evaluate whether these seven East Asian currencies were overvalued. The purchasing power parity calculations are performed on broad price indices, price indices of tradable goods, and price indices of export goods using the Johansen and Horvath-Watson cointegration test procedures. As of May 1997, the baht, ringgit and peso were overvalued according to this criterion. While the overvaluations are not large, they do appear to be persistent. Robustness checks for sensitivity to deflator, sample period, and numeraire currency are undertaken. Second, I calculate the implied equilibrium rates from a monetary model augmented by a proxy variable for productivity trends. The monetary models imply less substantial deviations from equilibrium. Furthermore, the results do not closely correspond to those obtained from the PPP calculations. Interestingly, both methods indicate that the Korean won was undervalued even before its recent discrete drop in value.

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