Estimating Equilibrium Real Exchange Rate And Misalignment In An Oil Exporting Country: Libya's Experience

Exchange rate misalignments has attract a significant attention especially in developing economies; Libyan economy has witnessed a major economic and political changes. Libyan exchange rate has been changed specifically after 2000, and political instability after 2011. This paper aims to shed a light on the equilibrium real exchange path to obtain the misalignments level (over and undervaluation) periods for the Libyan economy. This problem have not received an adequate intention from the policy makers in Libya. Cashin (2004) model is used to determine the main fundamentals that affect the equilibrium path. After applying time series analysis for a period (1975-2015). This paper utilized annual data covering the period (1975-2015); and the data extracted from Central Bank of Libya (CBL), International Financial Statistics (IFS), Organization for Economic Cooperation Development (OECD, Arab monetary Fund (AMF) and World Bank (WB). After testing stationarity of time series using ADF and P.P, this study applies co-integration technique to investigate long relationship between exchange arte and its fundamentals. Then, it performs the vector error correction model (VECM) to compare between long run and short relationships, supported by impulse response functions. The main findings of this study as follows. First, real oil prices and real relative productivity are found to play a significant role in the real exchange rate. For Libyan case, this study includes the degree of openness to this model because the Libyan authorities applied intensive restrictions to restrict external trade for a long time. Second, the results of VECM technique reveal that the speed of adjustment is 4.5 years for half-life to return to the actual level of exchange rate to the equilibrium path. In addition, the results from the impulse response functions (IRFs) found that the real exchange rate responds positively to the shocks in (rop) and (rrp), whereas responds negatively to the shocks in (open). Finally, the real exchange rate for the Libyan economy is recently overvaluation by more than 40%. This study provides some important policy implications for Policy maker specifically monetary authorities (Central Bank of Libya) should consider misalignments of Libyan exchange rate, and implement a proper policy to keep the exchange rate reasonably close to what fundamentals suggest. Policy makers should reduce money supply and increase exchange rate. A managed floating exchange rate policy could be a choice.