Editing Exchange rate (section)

==Real exchange rate equilibrium and misalignment==
The Real Exchange Rate (RER) represents the nominal exchange rate adjusted by the relative price of domestic and foreign goods and services, thus reflecting the competitiveness of a country with respect to the rest of the world.<ref name="auto">{{cite journal|last1=Dufrenot|first1=Gilles J.|last2=Yehoue|first2=Etienne B.|title=Real Exchange Rate Misalignment: A Panel Co-Integration and Common Factor Analysis|journal=IMF Working Paper|date=2005|volume=164}}</ref>  More in detail, an appreciation of the currency or a high level of domestic inflation reduces the RER, thus reducing the country's competitiveness and lowering the Current Account (CA). On the other hand, a currency depreciation generates an opposite effect, improving the country's CA.<ref name="auto1">{{cite journal|last1=Akram|first1=Q. Farooq|last2=Brunvatne|first2=Kari-Mette|last3=Lokshall|first3=Raymond|title=Real equilibrium exchange rates|journal=Norges Bank Occasional Papers|date=2003|volume=32}}</ref>

There is evidence that the RER generally reaches a steady level in the long-term, and that this process is faster in small open economies characterized by fixed exchange rates.<ref name="auto1"/>  Any substantial and persistent RER deviation from its long-run equilibrium level, the so-called RER misalignment, has shown to produce negative impacts on a country's balance of payments.<ref name="auto2">{{cite journal|last1=Jongwanich|first1=Juthathip|title=Equilibrium Real Exchange Rate, Misalignment, and Export Performance in Developing Asia|journal=ADB Economics Working Paper|date=2009|volume=151}}</ref>  An overvalued RER means that the current RER is above its equilibrium value, whereas an undervalued RER indicates the contrary.<ref>{{cite journal|last1=Di Bella|first1=Gabriel|last2=Lewis|first2=Mark|last3=Martin|first3=Aurélie|title=Assessing Competitiveness and Real Exchange Rate Misalignment in Low-Income Countries|journal=IMF Working Paper|date=2007|volume=201}}</ref>  Specifically, a prolonged RER overvaluation is widely considered as an early sign of an upcoming crisis, due to the fact that the country becomes vulnerable to both speculative attacks and currency crisis, as happened in Thailand during the [[1997 Asian financial crisis]].<ref>{{cite journal|last1=Jongwanich|first1=Juthathip|title=Real exchange rate overvaluation and currency crisis: evidence from Thailand|journal=Applied Economics|date=2008|volume=40|issue=3|pages=373–382|doi=10.1080/00036840600570961|s2cid=154735648}}</ref>  On the other side, a protracted RER undervaluation usually generates pressure on domestic prices, changing the consumers' consumption incentives and, so, misallocating resources between tradable and non-tradable sectors.<ref name="auto2"/>

Given that RER misalignment and, in particular overvaluation, can undermine the country's export-oriented development strategy, the equilibrium RER measurement is crucial for policymakers.<ref name="auto"/>  Unfortunately, this variable cannot be observed. The most common method in order to estimate the equilibrium RER is the universally accepted Purchasing Power Parity (PPP) theory, according to which the RER equilibrium level is assumed to remain constant over time. Nevertheless, the equilibrium RER is not a fixed value as it follows the trend of key economic fundamentals,<ref name="auto"/>  such as different monetary and fiscal policies or asymmetrical shocks between the home country and abroad.<ref name="auto1"/>  Consequently, the PPP doctrine has been largely debated during the years, given that it may signal a natural RER movement towards its new equilibrium as a RER misalignment.

Starting from the 1980s, in order to overcome the limitations of this approach, many researchers tried to find some alternative equilibrium RER measures.<ref name="auto"/>  Two of the most popular approaches in the economic literature are the Fundamental Equilibrium Exchange Rate (FEER), developed by Williamson (1994),<ref>{{cite book|last1=Williamson|first1=John|title=Estimating Equilibrium Exchange Rates|date=1994|publisher=Peterson Institute for International Economics}}</ref>  and the Behavioural Equilibrium Exchange Rate (BEER), initially estimated by Clark and MacDonald (1998).<ref name="auto3">{{cite journal|last1=Clark|first1=Peter B.|last2=MacDonald|first2=Ronald|title=Exchange Rates and Economic Fundamentals: A Methodological Comparison of BEERs and FEERs|journal=IMF Working Paper|date=1998|volume=67}}</ref> 
The FEER focuses on long-run determinants of the RER, rather than on short-term cyclical and speculative forces.<ref name="auto3"/>  It represents a RER consistent with macroeconomic balance, characterized by the achievement of internal and external balances at the same time. Internal balance is reached when the level of output is in line with both full employment of all available factors of production, and a low and stable rate of inflation.<ref name="auto3"/>  On the other hand, external balance holds when actual and future CA balances are compatible with long-term sustainable net capital flows.<ref>{{cite journal|last1=Salto|first1=Matteo|last2=Turrini|first2=Alessandro|title=Comparing alternative methodologies for real exchange rate assessment|journal=European Economy - Economic Papers|date=2010|volume=427}}</ref>  Nevertheless, the FEER is viewed as a normative measure of the RER since it is based on some "ideal" economic conditions related to internal and external balances. Particularly, since the sustainable CA position is defined as an exogenous value, this approach has been broadly questioned over time.
By contrast, the BEER entails an econometric analysis of the RER behaviour, considering significant RER deviations from its PPP equilibrium level as a consequence of changes in key economic fundamentals. According to this method, the BEER is the RER that results when all the economic fundamentals are at their equilibrium values.<ref name="auto1"/>  Therefore, the total RER misalignment is given by the extent to which economic fundamentals differ from their long-run sustainable levels. In short, the BEER is a more general approach than the FEER, since it is not limited to the long-term perspective, being able to explain RER cyclical movements.<ref name="auto3"/>