Ostry: `Multilateral exchange rate analysis serves as a useful cross-check for country-specific exchange rate assessments' (photo: Stephen Jaffe/IMF)
EXCHANGE RATE ANALYSIS
IMF Survey: Could you summarize key changes in how you approach exchange rate analysis at the multilateral level?
Ostry: In the early days of CGER, we relied on two approaches to assess the consistency of exchange rates with medium-term economic fundamentals. First, a macrobalance approach, where a norm for the current account is estimated and then compared with the projection of the IMF's World Economic Outlook five years out. The difference between the norm and the projected current account determines the extent of misalignment. A second approach was much simpler, and basically involved comparing the exchange rate to some historical trend or average value to get a direct estimate of misalignment.
When we decided to integrate emerging market countries into the CGER exercise, we had to go back to the drawing board to some extent. The objective was to have an approach that could accommodate the different economic structures in advanced and emerging market countries and that was robust.
Economic fundamentals
We did three things. First, the macrobalance approach was updated to include a richer set of economic fundamentals—this step was essential given the very different countries in the sample. Second, we now assess the medium-term trend in exchange rates on the basis of a set of fundamentals rather than, as before, on the basis of a simple historical average or time trend. And third, we added the so-called external sustainability approach, which looks at the relationship between the current account—or flow position—and the net international investment position—or stock position—of the country. The three approaches look at misalignment from different angles. This is why, when they point in a similar direction, we are pretty confident that we have captured economically relevant aspects of the problem.
IMF Survey: How will the new methodology help strengthen the Fund's advice on exchange rates?
Ostry: Country desks are ultimately responsible for exchange rate assessments in the IMF's country reports. This is as it should be—after all, the desks can take into account the full range of country-specific factors that a large multilateral exercise like the CGER cannot always do. At the same time, country desks will be interested in the CGER results, which impose multilateral consistency and can act as a useful cross-check to their analysis. This is all the more so now that the exercise covers much more of the world economy.
I see the CGER as helping IMF country teams engage with policymakers on issues surrounding exchange rate misalignment. Inevitably, IMF economists will need to have discussions with country authorities about the sources of possible currency misalignment:
Does it reflect unsustainable policies? Does it distort incentives for private sector behavior? Does it anticipate messy adjustment over the medium term? Or, on the contrary, is it much more benign, being merely part of a short-run adjustment path that the private sector already anticipates?
Global imbalances
Finally, I should emphasize that the new version of CGER by no means marks the beginning of bilateral exchange rate assessments by the Fund for emerging market countries—this has always been an important component of our work for the entire membership. But the broad country coverage of the exercise—and the enhanced benefits in terms of multilateral consistency—means that the CGER can play a more useful role than in the past in informing judgments about exchange rate misalignment in both advanced and emerging market countries. It may also be a helpful tool for guiding thinking about the role exchange rate adjustment might play as global imbalances are unwound, a topic that the forthcoming World Economic Outlook will be looking at in some detail.
IMF Survey: What lessons have you learned so far?
Ostry: As our paper makes clear, we are under no illusion that the estimates of exchange rate misalignment resulting from the CGER approaches are very precise. The uncertainty relates to a number of factors, including the potential instability of underlying macroeconomic links, differences in these links across countries, measurement problems, and the imperfect fit of the models themselves. Some of these problems may be even more severe in the case of emerging market countries where structural change may be playing a greater role and where limitations in terms of data availability and the length of data samples are more acute.
But this should not divert from the fact that the three methods do, in practice, tend to yield similar results in many cases. When we presented the paper late last year to the IMF's Executive Board, the consensus seemed to be that this methodology is state of the art—it is the best we can do at this point.
IMF Survey: What are the next steps in applying this approach?
Ostry: We plan to let this process run a little while and then take stock. We hope to see references to the CGER assessments in IMF country reports. My sense is that many country desks do make use of the assessments. But whether they refer explicitly to the CGER seems to vary: some do, some don't.
We also hope to improve understanding among government officials and policymakers about what we are doing, and so have undertaken outreach efforts that target this community. These have two-way benefits: the authorities learn about the framework and how it is used, and we get to learn from policymakers—as well as from market participants, academics, and others included in the outreach events—about areas for improvement.
