Students exposed to the pure theory of international trade have been seduced by visions of an imaginary world with few goods, each typically produced by several countries but nevertheless homogeneous. In the assumed absence of transport costs and trade restrictions, perfect commidty arbitrage insures that each good is uniformly priced (in common-currency units) throughout the world -- the "law of one price" prevails.
This Working Paper should not be reported as representing the views of the IMF. The views expressed herein are those of the author(s) and should not be attributted to the IMF, its Executive Board, ot its management. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. The paper describes six different methodologies that have been used to assess the equilibrium values of exchange rates and discusses their limitations. It applies several of the approaches to data for the United States as of 2006, illustrates that different approaches sometimes provide substantially different assessments, and asks which methodologies deserve the most weight in such situations. It argues that while it is generally desirable to consider the implications of several different approaches, since different approaches provide different types of perspectives, two of the methodologies seem particularly relevant for identifying threats to macroeconomic stability and growth.
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