ABSTRACT
In this chapter we return to the issue of equilibrium exchange rates. The chapter is intended to have two main themes. First, we noted in Chapters 2 and 3 that PPP does not seem to provide a good measure of a country’s equilibrium exchange rate. Are there any alternative measures that can be used for this purpose? As we saw in Chapter 3, one explanation for the poor performance of PPP is that there are real factors driving real exchange rates and once the real rate is conditioned on these factors many of the puzzles associated with PPP disappear. In this chapter we provide an overview of different alternative approaches to measuring equilibrium exchange rates that rely on such real factors. The second theme we address here is how to use an equilibrium exchange rate to assess if a currency is overvalued or not.
