A Cautionary Note on the Use of Exchange Rate Indicators
IMF Policy Discussion Papers, March 1, 1993
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- A Cautionary Note on the Use of Exchange Rate Indicators
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Bibliographic details
- Authors: Peter Wickham
- Published: March 1, 1993
- Series: IMF Policy Discussion Papers
- DOI: https://doi.org/10.5089/9781451972368.003
Overview
- Reviews the basis for the use of various popular exchange rate indicators by tracing their conceptual development, the links between these indicators, and how they are measured in actual practice.
- Considers difficulties in obtaining empirical counterparts to theoretical concepts and the limitations on the use of indicators likely to arise therefrom.
- Illustrates the behavior of various exchange rate indicators using data for Colombia and Kenya.
- Classified as a Paper on Policy Analysis and Assessment; the author(s) welcome comments on the text.
- Views expressed are those of the author(s) and do not necessarily represent those of the Fund.
Major findings and analytical points
- Conceptual development and links between multiple exchange rate indicators are reviewed and compared.
- Measurement practices and the translation of concepts into empirical indicators often encounter difficulties; these measurement issues limit indicator usefulness.
- Real-world illustration using Colombia and Kenya highlights how indicators can behave differently depending on data and measurement choices.
Methodological and measurement considerations
- Emphasizes tracing indicators from conceptual definitions to their empirical counterparts.
- Highlights specific limitations on the use of indicators that stem from practical measurement challenges.
- Notes the importance of understanding the relationships among indicators (nominal exchange rate, real exchange rate, price indexes, purchasing power parity concepts).
Illustrative cases
- Uses data for Colombia and Kenya to demonstrate indicator behavior and practical measurement issues.
Policy guidance and recommendations
- Exercise caution in applying exchange rate indicators without careful attention to their conceptual basis and measurement.
- Ensure clarity on which indicator is being used (nominal exchange rate, real effective exchange rate, price-deflated measures, etc.) and the underlying price indexes or deflators.
- Interpret indicators in light of measurement limitations and country-specific data circumstances illustrated by the Colombia and Kenya examples.