On exchange rate policy : the case of Egypt 1970-2001

Abstract EN

Sound Estimates of equilibrium exchange rate have become a cornerstone for any country that adopts an outward oriented macroeconomic management policy.

This paper attempts to construct an index for Egypt's Equilibrium Real Exchange Rate (ERER) for the period 1970- 2001 so that misalignment episodes can to detected and analyzed.

The paper starts by discussing the main concepts along with a brief summary of the literature on estimating ERER.

The paper proceeds with a concise overview of Egypt’s macroeconomic and exchange rate policies.

Further, a model based on Edwards (1989) is developed and employed to test for and estimate both a short-run error correction regression, as well as a long run co integrations specifications for ERER in Egypt.

Estimated coefficients from the co integration regression are used to generate a series of estimated long run real exchange rates and to construct misalignment index.

Empirical estimates underscore existence of substantial exchange rate misalignment over the examined period.

The findings support the argument that Egypt, based on its macroeconomic fundamentals and external position, should adopt a flexible foreign exchange arrangement.

As the exchange rate cannot be used, under the flexible arrangements, as an anchor for monetary policy, the study concludes by advocating inflation targeting as a framework for monetary policy in Egypt.