Currency Valuation: From Competitiveness to Coping Mechanisms

For decades, economists have searched for the “true” value of currencies — not the vulgar market price, but the morally upright, spiritually correct exchange rate that markets stubbornly refuse to respect. This quest has produced three valuation models: REER, FEER, and BEER — a progression that unintentionally charts the emotional life cycle of macroeconomics itself: anxiety, rationalisation, and intoxication.

We begin with REER. The Real Effective Exchange Rate, the profession’s first serious attempt at objectivity. REER measures how expensive a currency is relative to trading partners, adjusted for inflation, and comes with elegant charts that slope meaningfully upward or downward, like a cardiogram of competitiveness. When REER rises, economists solemnly announce “overvaluation.” When it falls, they whisper “undervaluation,” and everyone feels something important has been said.

Unfortunately, REER works best in a world where currencies equilibrate trade, capital flows obey gravity, productivity never surprises anyone, and geopolitics takes lunch breaks. In the real world, where capital moves faster than goods, supply chains don’t reprice, and FX behaves like a risk asset on caffeine, REER mostly functions as a narrative prop. It tells you something is wrong. It rarely tells you what happens next.

This created a crisis. If REER couldn’t locate fair value, perhaps the problem wasn’t the model. Perhaps fair value itself needed moral reinforcement.

Enter FEER, the Fundamental Equilibrium Exchange Rate.

FEER doesn’t ask what the exchange rate is. It asks what it ought to be. Specifically, the rate that would deliver internal balance—full employment, stable inflation—and external balance —a current account that doesn’t trigger awkward IMF conversations. In other words, FEER is the exchange rate that would prevail in a better world—one where fiscal policy behaves, productivity cooperates, elections stop interfering with macro optimisation, and capital flows read policy papers before moving.

FEER is beloved by institutions because it converts uncertainty into righteousness. It allows economists to declare “misalignment” without specifying relative to what observable reality. It also implies that if only currencies adjusted, productivity, savings behaviour, geopolitics, and demographics would obediently fall into line.

In practice, FEER estimates vary wildly depending on whose model you use, which assumptions you make about potential output, what you think the “sustainable” current account should be, and whether the chart is prepared before or after the policy decision. Two FEER models can disagree by 30% and still be presented with identical confidence bands and the phrase “staff estimates.”

But even FEER was not enough. Because sometimes currencies remain stubbornly misaligned even relative to their own moral equilibrium. Policymakers look at REER and say “overvalued.” They look at FEER and say “also overvalued.” Markets look at both and say “thank you for your thoughts,” before proceeding in the opposite direction.

At this point, economics did the only rational thing.

It invented BEER - the Behavioral Equilibrium Exchange Rate.

BEER finally admits the truth: currencies don’t move to equilibrate trade balances or macro fundamentals. They move to equilibrate vibes. BEER regresses exchange rates on whatever variables markets appear to care about such as interest rate differentials, terms of trade, capital flows, risk sentiment, portfolio preferences, and occasionally astrology and calls the fitted value “equilibrium.” The residual is then labelled “misalignment,” which is economics’ way of saying “markets are wrong, but differently from before.”

If REER is about competitiveness and FEER is about virtue, BEER is about coping.

Together, the trilogy forms the five stages of grief—denial, anger, bargaining, depression and acceptance—compressed into three acronyms, subsuming anger and depression:

• REER: Denial — “The market price is wrong.”
• FEER: Bargaining — “The market price is immoral.”
• BEER: Acceptance — “Fine, let’s just explain what it’s doing.”

Notice something remarkable. All three models produce precise-looking numbers with authoritative charts. All three routinely disagree with one another. A currency can be overvalued on REER, undervalued on FEER, and perfectly valued on BEER thus allowing policymakers to select whichever conclusion best supports the policy they already intended to implement.

This is not a bug. It is the feature.

Modern FX markets are driven less by trade competitiveness and more by interest rate differentials, capital mobility, institutional credibility, reserve status, geopolitical alignment, and global risk regimes. Currencies equilibrate portfolios, not prices. They respond to balance sheets, not balance of payments. Yet our valuation frameworks behave as if shipping containers still set exchange rates rather than bond yields and capital flows.

REER belongs to a world of goods arbitrage. FEER belongs to a world of benevolent planners. BEER belongs to a world where economists quietly surrender and start regressing reality.

The only logical next step is TEER—the Tactical Emotive Exchange Rate—which simply states that the currency is exactly where the central bank needs it to be for this week’s press conference. Or, may be, stick to my version of NEER—Neither Effective nor Equilibrium Rate—for whatever it’s worth!

Until then, policymakers will continue searching for fair value in a market with no stable equilibrium, armed with models that all agree on one thing with remarkable consistency: the exchange rate is always wrong, just in different ways, depending on who is presenting the slide.

In the end, macroeconomics may not have solved currency valuation. But it did accidentally solve branding.

And on that front, at least, BEER is finally the right model.