Real effective exchange rate misalignment and currency crisis in Iran

Abstract

This study aimed to examine real effective exchange rate (REER) misalignment in Iran and its relation to the currency crisis. The behavioral equilibrium exchange rate was employed to calculate the equilibrium exchange rate (EER), and misalignment was obtained using the exchange rate deviation from the equilibrium value. Using the autoregressive distributed lag (ARDL) method and data from 1986 to 2019, the long-run relationship between macroeconomic fundamentals and REER was estimated. The results show that trade openness, rate of productivity growth in tradable good production, net foreign assets of the central bank, oil exports, and terms of trade significantly affected the EER. Estimation of misalignment and its relationship with the currency crisis show that in the years before the crisis, there was generally a significant overvaluation in several consecutive years; hence, exchange rate misalignment serves as a leading index to predict the probability of a currency crisis.