Measuring exchange rate misalignments in China, Japan and South Korea 

This study measures the extent to which the real effective exchange rates of China, Japan, and South Korea are misaligned from their equilibrium values. The equilibrium values are estimated using the behavioral equilibrium exchange rate approach. Economic fundamentals, such as relative terms of trade, relative price of nontrade to trade goods, real interest rate differentials, and trade balance over trade volume, are employed to assess the equilibrium exchange rate from 1990Q1 to 2022Q1. While only two fundamental variables are significant for the entire sample period, the coefficient values of all four fundamental variables are significant and consistent with economic theories for the subsample period (2003Q1–2022Q1). In addition, the goodness-of-fit is fairly high for the subsample period, although the Great Recession occurred during this period. The exchange rate misalignments are measured for the subsample period based on the estimations of the equilibrium exchange rates. The Chinese renminbi was generally less misaligned than the other two currencies. In the prerecession period (2003Q1–2008Q3), the South Korean won was overvalued by as much as 21% at the peak, while the other two currencies were undervalued. In contrast, during the recession period (2008Q4–2012Q4), the Japanese yen was substantially overvalued, whereas the Korean won was in the opposite situation. During the post-recession period, the three exchange rates were less misaligned than before. However, they were all undervalued in 2022Q1, implying that they might have been misaligned again as the strong dollar era began.