Determination of long-run equilibrium exchange rates and real exchange rate misalignment: Case of Turkey

There is a consensus that real exchange rate misalignment has adverse effects on welfare. Permanent misalignments lead to deterioration of economic stability by sending the wrong signals to economic agents. Particularly real appreciation of domestic currency, make the economy more vulnerable to speculative attacks by adversely affecting the external competitiveness of the economy and sustainability of current account. Therefore, misaligned real exchange rates are seen as one of the mean reasons of the financial crisis occurred. Therefore, as an unobservable variable, determination of the equilibrium real exchange rate is of great importance for preventing economic instability. In this study, misalignment of real exchange rates for Turkey is determined separately with three equilibrium real exchange rate models including purchasing power parity theory, behavioral equilibrium exchange rate model and natural equilibrium exchange rate model. In analysis, cointegration techniques are adopted to obtain equilibrium real exchange rate. The results suggest that in Turkey, real exchange rates significantly deviated from its equilibrium level in 90's and early 2000's while fixed exchange rate regimes are implemented and converged to its equilibrium level after transition to flexible exchange rate regimes. Another critical finding obtained from the analysis is; crisis that occurred in Turkish economy have occurred after the periods of real appreciation of Turkish Lira. Keywords: Real Exchange Rate, Equilibrium Real Exchange Rate, Real Exchange Rate Misalignment