Real Exchange Rate Misalignment: Prelude to Crisis?

the sustainable or permanent values of the macroeconomic fundamentals.²⁰ In order to calculate
the permanent values of the macroeconomic fundamentals the time series decomposition
technique introduced by Beveridge and Nelson (1981) and simplified by Cuddington and
Winters (1987) is utilized in Section 8, below.

The model is particularly relevant to the transition economies, since with more liberal
policies, the growth of the traded goods sector relative to that of the non-traded goods sector may
have significant implications for the determination of the equilibrium real exchange rate. It
allows: (1) testing the empirical findings by Halpern and Wyplosz (1997), Balazs (2002) and de
Broeck and Slok (2001) that much of the real appreciations of the exchange rates in the transition
economies were due to changes in productivity conditions, and (2) confirming the observation by
Brada (1998), Drabek and Brada (1998) and Liargovas (1999) that significant net capital inflows
caused real appreciations of the exchange rates. Moreover, the model is simple in terms of data
requirements.

In the following section the estimation results for equations (4) and (5) for Russia and
Poland are presented and discussed (sections 4-7). Given the estimates of the permanent values
of the macro fundamentals and β, the exchange rate misalignments can then be calculated
(section 8), and out of sample forecasts can be made (section 9) to examine the potential for
exchange rate crises.

4. Tests for Stationarity

To verify whether the long run equilibrium equation can be specified as a cointegrating
relation, the order of integration (i.e. whether stationary, or stationary in the first or higher

²⁰ See equation (7) in section 8.

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