Misalignment under different exchange rate regimes: the case of Turkey

The paper examines misalignment of the Turkish lira between 1998 to 2008. Misalignment, specifically overvaluation has been linked to fixed exchange rate regimes. By studying the case of Turkey during this period which covers both a fixed and floating exchange rate regime, we contribute to the literature on the relation between misalignment and exchange rate regimes. We first estimate the equilibrium real exchange rate for Turkey, then compute misalignment and finally test for structural breaks in the misalignment series. Through our tests we find three structural regimes which we call the pre-crisis period, the transition period and the post-crisis period. We find considerable overvaluation in first regime, which is when Turkey had a fixed exchange rate regime. This was not the case for the periods that had floating exchange rates. Thus, we conclude that overvalued currencies that have been linked to financial crises are a more serious concern for fixed exchange rate regimes.