Real exchange rates in developing countries: concepts and measurement
Edwards, S.
International financial markets and agricultural trade: 56-108
1990
Document Number: 432095
Some of the most important aspects related to the concept and measurement of real exchange rates (RER) are analysed. In addition, an empirical analysis is provided of real exchange rate behaviour in a large group of developing countries. The discussion emphasizes that it is crucially important to make a distinction between equilibrium and disequilibrium changes of real exchange rates. For this reason, an intertemporal model of equilibrium real exchange rate behaviour in a fully optimizing economy is presented and how alternative macroeconomic policies can result in real exchange rate misalignment is discussed. The empirical analysis showed that in recent years bilateral and multilateral real exchange rates have exhibited markedly different behaviour, an indication that ignoring those problems emerging from the existence of a floating rate international monetary system can result in greatly biased policy recommendations. In a large number of developing countries parallel markets for foreign exchange can be quite important, so that using RER constructed with official nominal rates can also result in misleading conclusions. Finally, the effects of real exchange rate variability on economic development in a group of developing countries is empirically investigated. Using a cross-section data set, it was found that higher RER volatility has been associated with lower output growth and lower investment. There are no indications, however, that higher variability in the RER affects the level of exports.