Notes on Equilibrium Exchange Rates: January 2010

Abstract

In this update of estimates of fundamental equilibrium exchange rates (FEERs) for 30 major economies, Cline and Williamson report on changes in disequilibria in exchange markets since March 2009, the date to which their earlier (June 2009) calculations referred. The overvaluation of the dollar has been sharply reduced from March to the end of 2009, from about 17 percent to about 6 percent. The remaining overvaluation of the dollar would be completely eliminated if the five East Asian economies with seriously undervalued exchange rates were to appreciate to FEER-consistent levels: China (which needs the most appreciation), Hong Kong, Malaysia, Taiwan, and Singapore. Cline and Williamson find that in the important case of the euro, whereas the currency was undervalued against the dollar by about 17 percent in March 2009, by end-December it had closed to about 7 percent below its FEER-consistent rate. Japan's bilateral undervaluation had also narrowed but only slightly. Several currencies have overshot from substantial undervaluation to overvaluation against the dollar, including those of Australia, New Zealand, South Africa, Brazil, Indonesia, Hungary, and Poland. These economies typically have high interest rates, and their substantial currency overshooting reflects the shift in the international financial environment from acute panic and safe-haven influences in early 2009 to carry-trade dynamics by the end of the year in the face of zero US short-term interest rates. Two key trade partners for the United States, Canada and Mexico, have both swung from modest undervaluation against the dollar to somewhat greater overvaluation. The authors conclude with a reestimation of the FEER-consistent dollar rate for one important currency, the Korean won, and conclude that its FEER-consistent rate is now about 1,000 won to the dollar.