Exchange Rate Assessment : A Review of Concepts and Indicators

Real exchange rate volatility and real exchange rate misalignment have welfare costs: they generate incorrect signals that can misallocate resources and reduce economic efficiency. It is difficult to determine, both theoretically and practically, whether a country’s real exchange rate is misaligned. However, there are several indicators- exchange rate indices, relative price index, elasticities, commodity-specific analysis, parallel market exchange rate, and regression residuals- that can be used in assessing the appropriateness of the prevailing exchange rate. The objective of this paper is to review the concept of misalignment and the different indicators used in exchange rate assessment.