LONDON – I know from my 32 years in finance that the weird world of foreign-exchange markets can sometimes defy comprehension, and that trying to estimate sterling’s baseline, equilibrium value can be an exercise in futility.
Indeed, in the heady hour after the Brexit referendum polls closed on June 23, the British pound initially traded above a rate of £1.5/$1. This exchange rate turned out to reflect the now-ridiculous assumption that the “Remain” side had won. The pound has since declined 20% from that initial peak, and it has declined similarly relative to the euro.
Despite these discrepancies, we do have ways to gauge the pound’s post-Brexit performance reasonably well. For starters, we can compare its value today to its average value during the referendum’s campaign period, from February to June. Viewed from this perspective, the pound has declined by a still significant 13% since voters decided that the United Kingdom should leave the European Union.
Beyond looking at purchasing power parity, we also have models for estimating real-exchange-rate (RER) equilibrium, such as by identifying the exchange rate at which a country can achieve a sustainable current-account balance, or the rate that would allow an economy to reach full employment.