The primary motivation for the work of the Coordinating Group on Exchange Rate Issues is to identify cases where exchange rates appear to be substantially out of line with medium-run macroeconomic fundamentals. It is recognized that such situations can have different interpretations, depending on the cyclical positions of economies and other circumstances. Whether policymakers should take actions or make pronouncements when the methodology identifies possible misalignments is left as an open question, to be addressed on a case-by-case basis and in the context of considering the extent to which monetary, fiscal, and other policies are appropriate from a broader perspective.
CGER’s analysis, which has concentrated to date on industrial country currencies, has helped to form the basis for views expressed to national authorities43 and in international fora such as the Group of Seven. In keeping with guidance from the IMF Executive Board, CGER’s work has not been aimed at providing regular public assessments of currency alignments. On a number of occasions, however, CGER’s assessments have underpinned statements by the IMF’s staff and management expressing qualitative judgments about exchange rates among the major currencies, including in the World Economic Outlook exercise; and in some cases such assessments have appeared in published staff reports.
The assessments of exchange rates among industrial country currencies rely primarily on an application of a macroeconomic balance framework. This framework focuses on the extent to which the current account positions associated with prevailing exchange rates are consistent with medium-run fundamentals. CGER’s assessments also take account of purchasing power parity considerations, which provide perspectives on how much exchange rates deviate from historical trends in real terms (i.e., after adjusting for inflation). The formal analysis provides a starting point for a more judgmental assessment of the appropriateness of prevailing exchange rates in the context of a wider range of considerations, including the cyclical positions of national economies.
The macroeconomic balance methodology is based on comparisons of underlying current account positions with estimates of medium-run “equilibrium” saving-investment balances. The underlying positions are the external balances that would emerge at prevailing exchange rates if all countries were operating at potential output and the lagged effects of past exchange rate changes had been fully realized. The assessments rely on the WEO projections as measures of these underlying positions. The measures of equilibrium saving-investment balances are derived from an estimated equation, with judgmental adjustments, in some cases, for factors not captured by the equation. Given the estimates of underlying current account positions and equilibrium saving-investment balances, a globally consistent framework is used to calculate the amounts that multilateral and bilateral exchange rates would have to change, other things being equal, to adjust the underlying current account balances to their medium-run equilibrium positions.
CGER’s estimates of equilibrium exchange rates are not very precise. Imprecision emerges both from the limitations of the conceptual models and empirical techniques used to generate estimates of underlying current account positions and equilibrium saving-investment balances, and from the need to adjust for global current account discrepancies. Nevertheless, for cases where the assessments point to substantial deviations of exchange rates from their medium-run equilibrium levels, the qualitative findings are noteworthy. Retrospective applications of the CGER methodology to episodes that are widely regarded as extreme misalignments of the major currencies during 1980–95 would generally have delivered correct signals at the time.
Substantial discrepancies between exchange rates and their medium-run equilibrium levels, when they emerge, raise two different but related issues for the IMF to address in its exercise of bilateral and multilateral surveillance. One issue is whether such discrepancies imply that policy adjustments are warranted in the near term. A second question is how macroeconomic performance would be affected in the event of a sudden and sharp exchange rate correction.
The analytic framework that CGER uses to assess the current account and exchange rate positions of industrial countries rests on capital mobility assumptions that are not entirely appropriate for most emerging market economies. Accordingly, CGER has been developing an alternative methodology for the emerging market countries, focusing first on criteria for assessing whether their underlying current account deficits or surpluses may be unsustainable. CGER’s analysis of the sustainability of current accounts from a medium-run perspective is still at a preliminary stage. Over time, such analysis could contribute to assessing vulnerability to currency crises in the short run and complement ongoing work to develop and implement an early warning system based on a broader set of indicators.