Exchange Rate Misalignment and Long Run Equilibrium Exchange Rate: Assessing Behavioral Equilibrium Exchange Rate (BEER) Model for Indonesia

Abstract

This study is aimed to estimate the long run equilibrium exchange rate and the exchange rate misalignment of Indonesian Rupiah using the Behavioral Equilibrium Exchange Rate (BEER) model. BEER model is obtained from the Cointegration vector between the variable of the Real Effective Exchange Rate (REER) and economic fundamentals. Exchange rate misalignment is the deviation between actual real exchange rate and equilibrium real exchange rate. Based on the observations during January 2006 to June 2015 using monthly data, the results are obtained as follows; under the floating exchange rate system, exchange rate misalignment of Rupiah was relatively small and tends to approach the long run equilibrium exchange rate, i.e. with the average misalignment of 0.83%. The external shock as the effect of the global crisis in 2008 has made the exchange rate misalignment tend to increase and the real exchange rate tend to undervalued. The highest undervaluation of the exchange rate of Rupiah was equal to 3.52%, i.e. in February 2009 while the highest overvaluation of the exchange rate misalignment was equal to 1.62% in July 2010. During the study, we found that three economic variables, Terms of Trade (TOT), Ratio of Total Trade to GDP (Open), and Net Foreign Assets (NFA), respectively, have significant effects on the long run equilibrium exchange rate of Rupiah. However, variable relative price of non-tradable goods to tradable goods (TNT) do not statistically significant.