George Soros in 1992 he successfully bet $1 billion against the pound sterling,

Question

George Soros in 1992 he successfully bet $1 billion against the pound sterling, in what turned out to be the beginning of a new era in large-scale currency speculation. Under assault by Soros and other speculators, who believed that the pound was overvalued, the British currency crashed, in turn forcing the United Kingdom's dramatic exit from the European Exchange Rate Mechanism (ERM), the precursor to the common European currency, the euro, to which it never returned. Using concepts and tools we have studied in the course, can you suggest a way to judge whether a country’s currency is overvalued or undervalued?

Explanation / Answer

So to suggest a way to judge whether a country's currency is overvalued or undervalued ,the above stated idea was of course ,not the best way,it can help you to prove or make your point only when you have $1billion to bets against currencies).For this Luis A.V. Catão introduces a RER index(Real Effective Exchnage Rate )or the REER

The REER -It is an average of the bilateral RERs between the country and each of its trading partners, weighted by the respective trade shares of each partner.

Being an average, a country’s REER may be in “equilibrium” (display no overall misalignment) when its currency is overvalued relative to that of one or more trading partners so long as it is undervalued relative to others.

Also ,In the real world there are many costs that get in the way of a straight price comparison—such as transportation, trade barriers, and consumption preferences.

But the fundamental notion is that when RERs diverge, the currencies face pressure to change. For overvalued currencies the pressure is to depreciate and for undervalued currencies to appreciate. It can get more complicated, if factors such as government policies hinder normal equilibration of exchange rates, often an issue in trade disputes.

So above are the suggested way that help to judge whether the a country's currency is overvalued or undervalued

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