Real Exchange Rate Misalignment: Prelude to Crisis?



Real Exchange Rate Misalignment: Prelude to Crisis?

by

David M. Kemme, PhD1
Fogelman College of Business and Economics
The University of Memphis, Memphis, TN 38152
Email: [email protected]

Saktinil Roy, PhD

Fogelman College of Business and Economics
The University of Memphis, Memphis, TN 38152
Email: [email protected]

October 25, 2005

Abstract

A model of the long run equilibrium real exchange rate based upon macroeconomic fundamentals is
employed to calculate real exchange rate misalignments for Poland and Russia during the 1990s using the
Beveridge and Nelson (1981) decomposition of macrofundamentals into transitory and permanent
components. Short run movements of the real exchange rate are estimated with ARIMA and GARCH
error correction specifications. The different nominal exchange rate regimes of the two countries generate
different levels of misalignment and different responses to exogenous shocks. The average misalignment
in Russia is substantially greater than that in Poland, indicating incipient pressures to devalue the ruble
immediately preceding the August 1998 crisis. The half life of an exogenous shock is found to be much
shorter for Poland than for Russia in the pre-crisis period. Dynamic forecasts indicate that the movements
of the real exchange rate in the post-crisis period are significantly different from those in the pre-crisis
period. Thus, the currency crisis in Russia could not be anticipated with the movements of the real
exchange rate estimated with the macroeconomic fundamentals.

JEL Classification: F31, F36, P17

Keywords: Russia, Poland, equilibrium real exchange rates, misalignment, cointegration, exogenous
shocks, macroeconomic crises

RER Misalignment 10-25-05-DI

1 We would like to thank Ali Kutan and Richard Zhang for helpful comments on an earlier draft. All errors remain
the responsibility of the authors.



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