Abstract
This study used Vector Error Correction Model to estimates the behavioral equilibrium exchange rate (BEER) and the exchange rate misalignment in case of Pakistan for the period of 1980 to December 2006. To explain the behavior of real effective exchange rate, we have used seven economic variables, i-e. Government Expenditures (GOV), Degree of Openness (OPEN), Relative productivity (PROD), Monetary Policy Proxy (MP), Reserve to GDP (RES), Terms of Trade (TOT) and Net Capital Flow (NCF). The results indicate that the degree of misalignment ranged between -12.71 to 10.93 percent with zero reversion mean from 1980 to 2006. Furthermore, we have identified four episodes of undervaluation and three episodes of overvaluation. The BEER has been undervalue during 1987-92, 1996-97, and 1999-00 and overvalued during 2004-05, 1981-86, 93-95 and 2006. The estimates also showed that the misalignment getting smaller and smaller during 1980s ad 1990s; where the misalignment were 10 and -10 percent, while during 2000s the biggest variance was 3 percent.
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