Real Equilibrium Exchange Rate in Colombia: Thousands of VEC Models Approach

Behavioral Equilibrium Exchange Rate (BEER) models propose a wide range ofvariables as potential drivers of equilibrium real exchange rates (ERER). This gives rise to model uncertainty issues due to the often drastic dependence and variability ofERER on a particular set ofchosen variables. We address this issue by estimating thousands of Vector Error Correction (VEC) specifications using Colombian data spanning from the first quarter of 2000 to the fourth quarter of 2019. Based on an extensive literature review, we employ thirty-five proxies categorized among five fixed groups of economic fundamentals that underlie the ERER: Indebtedness, Fiscal sector, Productivity, Terms-of-Trade, and Interest Rate Differentials. Our approach derives an empirical distribution of ERER that allows us to determine with greater certainty, among hundreds ofplausible economic specifications, whether the real exchange rate is misaligned or in equilibrium.