1

Where are key currencies going?

Agnès Bénassy-QuéréGIC-Club du CEPII-Barclays, May 13 2008

2

1. Fundamentals

33

A forward-looking model

( )ttEa

ttttt faeiie ωσ −−+−= + ,02

1,*

tt

tt YP

Ω=ωwith

Rational expectations:

( ) ( ) ( )11,02*

1111, ++++++ −−−== tttEttttta

tt fEaiiEeEe ωσ

( ) ( ) ∞+

∞

=++

∞

=++ +−−−= ∑∑ tt

kktkttE

kktkttt eEfEaiiEe

0,0

2

0

* ωσ

Monetary policy Long termPortfolio choices, foreign imbalances

44

Monetary policy: euro/dollar

55

Other factors: euro/dollar

6

2. Equilibrium exchange rates

7

What equilibrium?

Sticky prices

Noise and bubbles

Flexible prices

Stock/flow adjustment under way

Productivity given

Flexible prices

Stock/flow adjustment achieved

Productivity catch up under way

Flexible prices

Stock/flow adjustment achieved

Productivity catch up achieved

Purchasingpower parity

Stable NFA (BEER,

NATREX…)

Internal and external balance

(FEER)

Marketequilibrium

Short run Medium run Long run Very long run

Our focus

8

Equilibrium net foreign asset positions

1980-2005

15 countries or zones (« G20 »):

Euro area, Japan, United States, UK,

Australia, Canada, Korea,

Argentina, Brazil, Mexico

China, India, Indonesia,

Turkey, South Africa

9

Observed and « equilibrium » NFA, 1980-2005

10

Observed and « equilibrium » NFA, 2005

11

Two concepts of equilibrium

Estimated equation: Q = f(NFA, TOT, PROD)

→ BEER*: predicted Q with equilibrium NFA

→ FEER**: Q consistent with NFA converging to equilibrium in T years

BEER

Status quo

FEER

* BEER for Behavioural Equilibrium Exchange Rate. (MacDonald, 1997; Clark&MacDonald, 1998).

** FEER for Fundamental Equilibrium Exchange Rate (Williamson, 1984).

12

Current account targets, 2005

Underlying Targets*Current account CA 1 CA 2 CA 3

Canada 0.1 1.1 -2.1 -0.8Euro area -1.4 -0.2 1.4 4.5Japan 4.3 1.1 -6.0 -4.3UK -1.6 -2.6 2.6 8 .1USA -5.9 -3.0 2.7 -0.7Argentina 5.3 -1.5 2.4 3.8Australia -6.9 -2.2 2.1 3.1Brazil 0.1 -1.5 1.0 1.4China 10.0 2.6 -6.2 -5.6India -1.3 -0.7 -3.7 -8.8Indonesia 2.0 -0.7 -3.6 1.7Korea -1.0 -0.5 -2.7 -2.1Mexico -1.2 -1.5 0.5 0.8South Africa -3.0 -1.5 -1.7 -0.9Turkey -4.6 -2.2 -1.4 -1.1* CA 1: Williamson (2006) for USA. Canada. Japan. euro area. UK. Korea and China; IMF(2006) for other countries. CA 2: current account that would make the NFA converge to itsequilibrium level in 5 years. CA 3: idem CA 2 with 20% krash in US asset prices.Source: Bénassy-Quéré et al. (2008).

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Real effective misalignments in 2005(+ = undervalued)

BEER FEER 1 FEER 2 FEER 3 FEER 2’Canada 5.8 -4.1 9.1 3.7 2.7Euro area -4.7 -9.3 -21.8 -46.9 -6.3Japan 2.1 33.4 108.0 89.8 31.7UK -12.1 6.0 -25.2 -58.3 -6.6USA -2.1 -48.5 -142.9 -86.2 -30.6Argentina 63.3 89.7 38.5 19.4 8.5Australia 1.4 -40.1 -76.9 -85.4 -20.5Brazil -27.1 30.6 -18.5 -25.0 -4.2China 22.3 73.9 161.7 156.2 31.1India 5.9 -36.2 152.4 47.3 29.0Indonesia 10.1 30.4 63.3 3.5 11.6Korea -15.9 -5.4 16.7 10.1 2.8Mexico -14.2 -43.9 -27.6 -32.1 -3.8South Africa 2.0 -22.4 -19.9 -31.9 -3.0Turkey 0.5 -52.9 -70.5 -77.2 -7.6Note: a positive sign refers to an under-valued currency compared to equilibrium.

Source: Bénassy-Quéré et al. (2008).

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Bilateral euro/dollar misalignment at end 2007

Misalignmentin 2005 (%)

RER variation2005-2007(%)

Misalignmentin 2007 (%)

EUR/USDdec. 2007

Equilibriumexchange rate

EUR/USD dec. 2007BEER -5.9 -14.8 -20.7 1 .45 1.15FEER 1 25.0 -14.8 10.2 1 .45 1.60FEER 2 67.9 -14.8 53.1 1 .45 2.22FEER 3 13.3 -14.8 -1.5 1 .45 1.43FEER 2’ 14.8 -14.8 -2.2 1 .45 1.42

Note: a negative sign point to the euro being over-valued against the USD.Source: Bénassy-Quéré et al. (2008).