The euro/dollar equilibrium real exchange rate. A continuous time approach

In this paper, after a review of the various approaches to the REER, we focus on the NATREX class of models. It is based on a specific theoretical dynamic stock-flow model to derive the equilibrium real exchange rate. The equilibrium concept reflects the behavior of the fundamental variables behind investment and saving decisions in the absence of cyclical factors, speculative capital movements and movements in international reserves. Two aspects of this approach are particularly worth noting. The first is that the hypotheses of perfect knowledge and perfect foresight are rejected: rational agents that efficiently use all the available information will base their intertemporal decisions upon a sub-optimal feedback control (SOFC) rule, which does not require the perfect-knowledge perfect-foresight postulated by Representative Agent Intertemporally Optimizing Model, but only requires current measurements of the variables involved. The second is that expenditure is separated between consumption and investment, which are decided by different agents. The consumption and investment functions are derived according to SOFC, through dynamic optimization techniques with feedbackcontrol. Thus the NATREX approach is actually an inter temporal optimizing approach, though based on different optimization rules.