What determines the extent of real exchange rate misalignment in developing countries?

Nigeria: Should the Government Float or Devalue the Naira?

“…Providing an answer to the question of ‘whether to float or to devalue the naira’ cannot be arrived at without establishing whether and to what extent the current real exchange rate (RER) deviates from the equilibrium exchange rate of the economy, that is, the level of exchange rate misalignment, since the effectiveness of the devaluation tool depends on it. Nouira and Sekkat () opined that to assess the extent of currency misalignment it is necessary to compare the observed exchange rate, in this case the real effective exchange rate (REER), with its equilibrium value (EREER), which is the value it should have been under the hypothesis that the macroeconomic equilibrium is maintained. However, the equilibrium exchange rate is not directly observable and the literature provides three ways, namely the purchasing power parity equilibrium exchange rate approach, the fundamental equilibrium exchange rate approach and the behavioural equilibrium exchange rate approach (see Nouira and Sekkat, ).…”

“…Nouira and Sekkat () opined that to assess the extent of currency misalignment it is necessary to compare the observed exchange rate, in this case the real effective exchange rate (REER), with its equilibrium value (EREER), which is the value it should have been under the hypothesis that the macroeconomic equilibrium is maintained. However, the equilibrium exchange rate is not directly observable and the literature provides three ways, namely the purchasing power parity equilibrium exchange rate approach, the fundamental equilibrium exchange rate approach and the behavioural equilibrium exchange rate approach (see Nouira and Sekkat, ). This study employed the behavioural equilibrium exchange rate approach to determine the equilibrium real effective exchange rate.…”

“…Misalignment is then measured as the difference between the REER and the EREER. Following Nouira and Sekkat (), technological progress (productivity) is proxied by the ratio between the country's real per capita GDP and the geometric mean of the same variable in ten trading partners.…”

Real Exchange Rate Misalignment in Jordan: The Permanent Equilibrium Approach

“…So, the higher the fixity of exchange rate regime the higher the exchange rate misalignment. Fixed exchange rate systems can maintain non-trivial misalignment for a long period of time due to massive central bank interventions and the stickiness of prices especially in less efficient goods markets as in the case of developing countries (Nouira & Sekkat, 2015) (Note 1).…”

“…This is because a change in the relative prices of the base country's goods and the following country's goods misaligns the real exchange rate from its long-run equilibrium level, stated by domestic macroeconomic fundamentals. The persistent deviation from the long-run equilibrium has effects on a variety of economic variables such as economic growth, currency crisis, foreign direct investment and capital accumulation (Nouira & Sekkat, 2015). Thus, measures of misalignment are used for prediction of future depreciation and evaluation of the links between exchange rates and economic performance.…”