Following up on my misalignment post from Tuesday, here’s a volume compiled by the GAO when it was the General Accounting Office containing a symposium on exchange rates. The symposium took place in the midst of currency overvaluation: “Floating Exchange Rates in an Interdependent World”. The authors included Richard Cooper, Stanley Black, Rudiger Dornbusch, Jeffrey Frankel, and Jacob Frenkel.

Of particular interest is Jeffrey Frankel’s “The 1980-83 Dollar and Six Possible Meanings of Overvaluation” (p. 90 onward).

This paper considers six possible, very distinct, definitions
of the words “overvaluatlon” and “undervaluation,” or the
equivalently ambiguous term “disequilibrium.”

First, the words could refer to a situation in which the
exchange rate is at a level at which the supply of foreign exchange
does not equal the demand. This possibility, nonclearing of
financial markets, is dismissed out of hand in light of the very
low levels of transactions costs, capital controls and other
barriers to portfolio ad’justment among most of the major
industrialized countries.

Second, overvaluation of a currency could mean that its
private supply exceeds its private demand: i.e., that there is
foreiqn exchange intervention by one or more central banks to
support the value of the currency at a level higher than it would
be in a completely free market.

Third, overvaluation could be used to describe a currency that
has a higher value than that dictated by long-term fundamentals but
that is determined by short-term fundamentals, such as the real
interest rate or the current account surplus. This is the
phenomenon of overshootinq and is discussed in section III.
Fourth, overvaluation could mean that one can, in expectation,
make money by selling the currency forward. This is the
possibility of irrational expections discussed in section IV.

Fifth, overvaluation could mean that, even though expectations
are rational, the exchange rate nevertheless diverges from the
equilibrium determined by fundamentals, short-run as well as
long-run, This is the possibility of speculative bubbles discussed
in section V.

Sixth, overvaluation could pertain to the real effects of the
exchange rate, rather than its determinants. Under this
interpretation the loss in competitiveness by the export and
import-competing industries is undesirable, or the reverse effects
on the corresponding industries in foreign countries are
undesirable for them. The possibility of undesirable welfare
effects is addressed in section VI.

A later version of the article is available as “Six Possible Meanings of ‘Overvaluation’: The 1981-85 Dollar,” Essays in International Finance No. 159, International Finance Section, Princeton University: Princeton, December 1985.