Does Euro or Dollar Pegging Impact the Real Exchange Rate? The Case of Oil and Commodity Currencies

Abstract The aim of this paper is to investigate the equilibrium exchange rates for commodity and oil currencies as well as the discrepancies of their observed exchange rates to these equilibriums. To this end, first, we estimate a long‐term relationship between the real effective exchange rate and economic fundamentals, including the commodity terms of trade. The estimation relies on panel cointegration techniques and covers annual data from 1980 to 2007. Our results show that real exchange rates co‐move with commodity prices in the long run and respond to oil price somewhat less than to commodity prices. Second, we assess the degree of misalignment of these currencies, as the gap between their observed exchange rate and the estimated equilibrium exchange rate. We show that these misalignments are not significantly related to the exchange rate regimes adopted by the countries, either pegged or floating. However, for pegged currencies, the size of misalignments significantly depends on the anchor currency, either the euro or the dollar. A comparison of misalignments of pegged commodity and oil currencies across different periods confirms these results: during periods of dollar (euro) overvaluation, currencies pegged to the dollar (euro) tend to be overvalued; the reverse being true when the dollar (euro) is undervalued. Consequently, pegged currencies are often driven away from their equilibria by wild fluctuations in the key currencies, on which they are anchored.