The pattern of exchange rate misalignments prior to currency crises in Brazil: an ARDL bounds testing approach

This paper examines real effective exchange rate (REER) misalignments preceding currency crises in Brazil under the flexible exchange rate regime adopted in 1999. Using quarterly data from 2001:Q4 to 2022:Q4, the methodology proceeds in three stages: first, we estimate the equilibrium REER through an autoregressive distributed lag (ARDL) model with macroeconomic fundamentals and the Bounds test; second, we compute misalignments; and third, we identify currency crises via sharp depreciation thresholds. The analysis then contrasts misalignment patterns with crisis episodes. Robustness is confirmed through FMOLS, alternative productivity proxies, and a sensitivity analysis to obtain the permanent values of the series, comparing two different filters. The results show that labor productivity, trade openness and interest rate differentials are long-run determinants of the REER. Exchange rate misalignments, although moderate, systematically exhibit an appreciation pattern four quarters before crisis onset. These crisis episodes, lasting one to three consecutive quarters, occur when quarterly depreciation exceeds the dual threshold, defined as a 15% deviation from the exchange rate trend and at least a 10% depreciation relative to the same quarter of the previous year. Policy implications underscore the need to strengthen macro fundamentals and monitor REER misalignments as early warning signals to mitigate crisis risk in Brazil.