Real Exchange Rate Misalignment in a Collapsing Economy: An Anatomy of the Equilibrium Exchange Rate in Zimbabwe Currency

Real exchange rate (RER) misalignment, defined as a sustained deviation of the RER from its long run equilibrium is a very serious problem in developing countries. Moreover, it is prominently argued that the post-2000 economic crisis in Zimbabwe was a result of a chain of events that has its roots in the failure by monetary authorities to maintain an ‘appropriate’ level of the RER. This paper adopts the single equation reduced form behavioural approach to equilibrium RER (ERER), pioneered by Edwards (1989) to estimate the ERER and level of misalignment for Zimbabwe from 1985 to 2004. The findings indicate significant evidence of prolonged and very high levels of RER overvaluation during the entire sample period. Episodes of RER misalignment are particularly pronounced during the fixed exchange rate eras. They reach extreme levels of up to 95 percent in 2003-2004 – a period during which the economic also severely deepened. Despite sample period and data limitations, the findings nevertheless provide valuable insight as to what would have been the state of the Zimbabwean dollar in the lead up to its eventual abandonment in January 2009.