Economic convergence and the fundamental equilibrium exchange rate in Poland

Abstract

The paper presents an extended version of the fundamental equilibrium exchange rate model (FFER). By introducing potential output into the specification of the foreign trade equations of the partial equilibrium FEER model we show that, under some plausible assumptions, the calculated level of the equilibrium exchange rate is consistent with the estimates of the behavioral equilibrium exchange (BEER). Moreover, we indicate that including the terms of trade as an explanatory variable in a reduced-form BEER equation for the real exchange rate might lead to the indeterminacy of the parameter estimates. The proposed model is applied to analyze fluctuations of the Polish zloty. We show that the real appreciation of the zloty is to a largely an equilibrium phenomenon.Fundamental equilibrium exchange rate; current account; foreign trade