Natural Equilibrium Real Exchange Rate in Korea

Abstract

This paper defines an equilibrium time path of the real effective exchange rate of the Korean won. Once we know the equilibrium real exchange rate of the Korean won, we can calculate the degree of its misalignment. An estimate of the NATREX (NATural Real EXchange rate) model shows that the real exchange of the Korean won has a strong long run relationship with key economic fundamentals, such as total factor productivity, the input factor of raw material import, terms of trade, the world real interest rate and the population dependency ratio. Results also indicate that the Korean won shows cyclical movements of overvaluation and undervaluation in turn, rather than a systematic misalignment in one direction. Specifically, the Korean won was overvalued by 3.2% in 2006:Q1. Considering the cyclical pattern of misalignment, systematic intervention in the foreign exchange market does not seem to be desirable, except for unusual cases.

Keywords

• NATREX
• Equilibrium Real Exchange Rate
• Misalignment
• Korean won