An Assessment of the Real Exchange Rate Misalignment in Egypt: A Structural VAR Approach

Abstract

This paper calculates the equilibrium real effective exchange rate for the Egyptian economy during the period (1974-2012). The paper reviews the evolution of Egypt’s exchange rate policy and the most significant developments of its real effective exchange rate during the same period. Using a structural vector auto-regression model identified with long-run restrictions, it evaluates the relative importance of real supply, demand and nominal shocks to the disturbances of Egypt’s real effective exchange rate. The identified shocks and their impulse responses are consistent with the theoretical priors stemming from the Mundell-Fleming model. The main contribution to the fluctuations of the real effective exchange rate, roughly 80 percent, comes from both real demand and supply shocks. The model is used to check if the real exchange rate in Egypt is misaligned during the period under investigation. It shows that the actual real effective exchange rate has deviated from the equilibrium real effective rate with various degrees during the estimation period