assess the equilibrium exchange rate and measure the extent of misalignment.<sup>1</sup> In this paper, I measure misalignment in the CFA zone since the euro introduction using a traditional relative PPP methodology with a base year representing the equilibrium real effective exchange rate. I constructed a panel dataset of two separate real effective exchange rate series for both CFA zones (UEMOA and CEMAC) from January, 1999 to December, 2004. Nineteen countries were selected in UEMOA and thirteen were selected in CEMAC based on their trade shares with the zone, and sixty monthly calculations were made for each country to compute the bilateral effective exchange rate.

Using methodology adapted from Hinkle and Nsengiyumva (1999), I calculated a monthly real effective exchange rate index for the two zones in which a trade-weighted nominal effective exchange rate is adjusted for relative inflation in the home country and its trading partners. The multilateral real exchange rate was defined as a geometric product of the bilateral real effective exchange rates. Trade weights using both imports and exports are averaged for two years and are calculated for each regional grouping, while monthly CPI indices are calculated for the two zones and for the trading partners based on a weighted average of individual countries’ monthly CPIs. Monthly exchange rates are used in the model to ensure the minor fluctuations in exchange rates are captured in the analysis. A 1999 base year is chosen in which it is assumed that the balance of payments was in equilibrium, and the percentage difference between the actual and equilibrium exchange rate measures the extent of misalignment. This approach also assumes a constant equilibrium exchange rate and stable long-run parameters within the period. While the approach has certain shortcomings, it has a number of practical advantages in estimating the equilibrium RER in low-income developing countries: The simplest methods of estimating the long-run equilibrium RER are based on relative PPP. Although more sophisticated methodologies that take into account variations in the fundamentals determining the LRER have been developed, the PPP-based approaches are still widely used in both graphical analyses of individual countries and in econometric analyses of large multicountry samples... Its data requirements are limited. The methodology is both straightforward and transparent. With simple computer spreadsheets it is easy to run extensive sensitivity analyses of the results assuming different base years or means. A number of multicountry statistical analyses of misalignment are also available for comparative purposes. These are significant practical advantages for balance-of-payments management in a developing country in which data and professional manpower may both be limited...PPP-based analysis is also widely used for making initial diagnoses of individual countries. (Ahlers and Hinkle, p. 296; 312-313, 1999) In the second part of the paper, following Edwards (1989) and Baffes, Elbadawi, and O’Connell (1999), I use another more complex but less data-intensive methodology involving time series cointegration techniques, as well as the Engle-Granger two-step procedure and error correction modeling, to try to estimate the long-run equilibrium exchange rate as the function of the terms of trade, economic openness, aid inflows, and pre and post-devaluation scenarios. While it is well-known that currencies depart from their long-run values, the method attempts to find if there is a longer-run equilibrium where the fundamentals converge.

> 1 Four principal methods have been used in the extensive literature: a relative purchasing power parity-based methodology that assumes a stationary long-run equilibrium exchange rate, a target resource balance methodology that employs trade equations and elasticities, a single equation approach that estimates the equilibrium exchange rate as a function of several fundamentals, and simulations based on empirical general equilibrium models. (Williamson, 1994; IMF, 1998; Hinkle and Montiel, 1999)

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