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Properties of the fundamental equilibrium exchange rate in the Treasury model

Published online by Cambridge University Press:  26 March 2020

Keith B. Church
Keith B. Church*
Affiliation:
ESRC Macroeconomic Modelling Bureau, University of Warwick, CoventryCV4 7AL
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Abstract

This article calculates the equilibrium real exchange rate for the UK economy. The long-run trade and supply side relationships from HM Treasury's model are used to estimate the level of the real exchange rate consistent with the UK economy growing at its ‘natural’ rate while achieving a sustainable current account position. The model shows that the real exchange rate associated with macroeconomic equilibrium lies well below the actual rate for most of the 1990s. This result has important implications for possible UK participation in the single European currency as, once the nominal exchange rate is fixed, overvaluation can only be corrected by holding UK inflation lower than that elsewhere. Achieving this may be costly in terms of jobs and output.

Type
Articles
Information
National Institute Economic Review , Volume 169 , July 1999 , pp. 96 - 104
Copyright
Copyright © 1999 National Institute of Economic and Social Research

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Footnotes

∗

I am grateful for the advice and comments of Ray Barrell and James Sefton although the interpretation of the results remains my responsibility. This research is supported by a grant from the Economic and Social Research Council.

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