Properties of the Fundamental Equilibrium Exchange Rate in Models of the UK Economy

Abstract

The Fundamental Equilibrium Exchange Rate (FEER) is that value of the real exchange rate that is consistent with macroeconomic equilibriumo This article uses the long-run trade equation elasticities from the models of Her Majesty's Treasury, the National Institute of Economic and Social Research and the Bank of England to examine the FEER calculation. The sensitivity of the results to changes in the key elasticities and to the possibility of a recent improvement in UK trading performance is considered. Historical comparisons are made between the FEER and the actual real exchange rate. All the results suggest that the real exchange rate was above the FEER at the time of ERM entry. The fixing of the nominal exchange rate removes a possible mechanism by which the economy might reach equilibrium and therefore convergence requires a period where UK inflation is lower than that of its trading partners.

Get full access to this article

View all access options for this article.

References

Barrell, R. and Wren-Lewis, S. (1989), 'Fundamental equilibrium exchange rates for the G7', Centre for Economic Policy Research Discussion Paper No.323.

Barrell, R. and In't Veld, J.W. (1991), 'FEERs and the path to EMU', National Institute Economic Review, No.137, 51-58.

Barrell, R. , Gurney, A. and In't Veld, J.W. (1992), 'The real exchange rate, fiscal policy and the role of wealth: an analysis of equilibrium in the monetary union', Journal of Forecasting, forthcoming.

Bray, J. , Hall, S. , Meen, G. , Westaway, P. and Whitley,J.D. (1992), 'UK policies, non-price competitiveness, and convergence to an EMU', ESRC Macroeconomic Modelling Bureau Discussion Paper No.28.

Holly, S. , and Wade, W. (1959), 'Focus: Supply-side improvements in UK exporting of manufactures', Economic Outlook 14, 35-37.

Landesmann, M. and Snell, A. (1989), 'The consequences of Mrs Thatcher for UK manufacturing exports', Economic Journal, 99, 1-27.

Williamson, J. (1983), The Exchange Rate System, Cambridge, Mass: MIT Press.

Williamson, J. (1991), 'FEERs and the ERM', National Institute Economic Review, No.137,45-50.

Wren-Lewis, S. (1992), 'On the analytical foundations of the Fundamental Equilibrium Exchange Rate', In C.P. Hargreaves (ed), Macroeconomic Modelling of the Long Run, pp.323-338, Aldershot: Edward Elgar.

10.

Wren-Lewis, S. , Westaway, P. , Soteri, S. and Barrell, R. (1991), 'Evaluating the UK's choice of entry rate into the ERM', Manchester School, 59, 1-22.