Real Exchange Rate Misalignment: Prelude to Crisis?



misalignment in Russia, however, is significantly higher and the misalignment measures in
Russia prior to the currency crises in August 1998 clearly indicate incipient pressure to devalue
the ruble. The results also indicate that the real appreciations in these transition economies are in
part due to significant net capital inflow4 and productivity shocks5.

Short run movements of the real exchange rate in the pre-crisis period versus the post
August 1998 period are also examined for Russia. Out of sample forecasting exercises are
performed for the post-crisis period. The movements of the real exchange rate in the post-crisis
period are significantly different from those in the pre-crisis period, indicating that the currency
crisis in Russia could not be anticipated by the movements of the real exchange rates as
estimated with the macroeconomic fundamentals.

In the next section a brief review of the literature on real exchange rate determination and
studies on Eastern Europe in particular are presented. Section 3 outlines the basic model and
definitions of the real exchange rate and equilibrium real exchange rate adopted in this paper. In
sections 4 and 5 cointegration tests are performed and a model of the determination of the long
run equilibrium exchange rate is estimated. The short run error correction model is estimated in
section 6 and exogenous shocks examined in section 7. The long run equilibrium real exchange
rate and misalignments are calculated in section 8 using a method for decomposing
macroeconomic variables into their permanent and transitory components first developed by
Beveridge and Nelson (1981). The misalignment results obtained for Russia and Poland are
compared and contrasted. While large real exchange rate misalignments were apparent prior to
the August 1998 crisis, simple out-of-sample forecasting based upon macro fundamentals,

4 See Brada (1998), Drabek and Brada (1998), and Liargovas (1999) for a discussion of capital inflows.

5 See Richards and Tersman (1996), Halpern and Wyplosz (1997), Balazs (2002), de Broeck

and Slok (2001) for a discussion of productivity shocks.



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