market, shifting resources from the productive sector to the informal financial sector. Finally, a widening gap between official and parallel market rates added pressure to the legal economy by generating expectations of another devaluation, since it signaled the possibility that the government could not support the exchange rate with its stock of international reserves.

On December 16, 2015, the government announced its decision to remove the capital controls and currency restriction and let the peso float within certain limits. As a result, the currency immediately depreciated by 30 percent and the gap with parallel rates virtually closed. The removal of the _cepo_ boosted the debate on the exchange rate equilibrium levels. What is the exchange rate equilibrium level based on the fundamentals of the Argentine economy? What could be the equilibrium level going forward, in a context where economic fundamentals are expected to evolve?

To address these questions, this paper uses a model-based approach known as the behavioral equilibrium exchange rate (BEER), which allows the equilibrium exchange rate to vary over time according to fundamentals in the economy. A reducedform single-equation vector error correction model is estimated by employing Johansen’s (1995) approach using monthly data spanning from 1980 to 2015. The analysis identifies fundamental factors driving Argentina’s real exchange rate to be: the terms of trade, productivity differentials, trade openness, and reserves. While doing so, the analysis takes into account important features specific to Argentina in constructing adjusted measures of the REER and productivity differentials, such as: potentially underestimated inflation, potentially overestimated output, and a large share of agriculture in exports. Based on this approach, estimation results suggest that, as of October 2015, the peso was overvalued by 39%.

As a robustness check, the estimates of exchange rate misalignment are compared to alternative estimation-based methods, which signal that the peso was overvalued by approximately 34–46%, as of October 2015. Premia on parallel exchange markets are indicative of the magnitude of overvaluation, and had been widening since 2011 and reached about 34–36 percent in December 2015, before the removal of capital and currency controls. Arbitrage conditions in goods markets also provide measures of currency overvaluation, but need to be interpreted with caution. Indicators relying on the law of one price (LOP), such as the Big Mac and iPad indices, equate goods prices across countries once converted in a common currency, assuming the absence of trade barriers and price controls, and price discrimination. Purchasing power parity (PPP), which implies the real effective exchange rate should be constant (normalized to a year in which it is assumed to be in equilibrium), suggests the peso is undervalued. Artificially low prices in recent years caused these indicators to be misleading. Upon correcting the REER for discrepancies in inflation statistics reported by official vis-à-vis alternative private sector sources, PPP signaled the peso to be overvalued in October 2015 by approximately 46 percent.

The remainder of the paper is structured as follows. Section 2 provides a literature review on the estimation of equilibrium exchange rates, its different approaches and empirical findings. Section 3 explains the methodology and data employed in the BEER analysis. Section 4 presents a range of estimates of the peso’s misalignment using the BEER approach, conducts a series of robustness checks, and contrasts findings to estimation-based approaches using parallel rate premia, LOP, and PPP. Finally, Section 5 summarizes the findings and concludes.

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