Exchange Rate Misalignment in Pakistan: Evidence from Purchasing Power Parity Theory

Abdul Qayyum, Muhammad Arshad Khan, Khair-u- zaman


Exchange rate provides a key link between the domestic and
world markets for goods and assets. Therefore, a proper and detailed
analysis of the behaviour of exchange rate is required. There is also
growing agreement that prolonged and substantial exchange rate
misalignment can create severe macroeconomic disequilibria and the
correction of external balance will require both exchange rate
devaluation and demand management policies. Thus the policy-makers have
used PPP theory as a guide to represent the external competitiveness of
a country, and as a benchmark against which floating exchange rates are
judged to be misaligned. Developments in 1990s and 2000s show that cost
associated with exchange rate misalignment is very high. Hence, the
analysis of exchange rate determination in the presence of exchange rate
misalignment is crucial for the policy purpose because of its role as a
component of an early warning system [Berg, et al. (2000)].

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