Estimates of Fundamental Equilibrium Exchange Rates, November 2017

William Cline

No PB17-31, Policy Briefs from Peterson Institute for International Economics

Abstract: The early boost to the dollar following President Donald Trump's election—a Trump "bump"—has been replaced by a Trump "dump." The real effective exchange rate (REER) for the US dollar fell by 6.3 percent from its monthly peak in December 2016 to the October base period used in this study. As a consequence, whereas the dollar was overvalued against its FEER by 8 percent in May, its overvaluation has narrowed to about 4 percent. Through mid-May the dollar's decline could be explained by changes in interest differentials against other major currencies, but thereafter a growing gap emerged in an apparent reflection of increased US political risk, from both domestic political dysfunction (with the failure to repeal the Affordable Care Act) and escalating tension with North Korea. A weaker dollar should help curb the widening of the US trade deficit and potential associated escalation of trade conflict. Cline also evaluates congressional tax reform proposals and estimates the magnitude of the revenue loss as likely to be in the range of 1 percent of GDP annually or less, which suggests that the scope for an upsurge in the dollar from tax reform may be modest rather than massive.

Date: 2017-11
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