# What does it mean if a country's exchange rate is said to be “overvalued”?

For instance, China's or Switzerland's currencies are often said to be overvalued.

This is hard to define because in general in economics the definition of overvaluation of currency is very vague. In economics overvaluation or undervaluation would be a deviation from a person’s expectation of purchasing power parity (PPP) should be (see the textbook Money, Banking and Financial markets from Schoenholtz).

So technically if you think that 1 dollar should purchase 1 euro in long run, but actually the real-life exchange rate is such that it can purchase 1,1 euro you would say the dollar is overvalued.

This being said in actual research we don’t just try to guess what the proper exchange rate should be, but we estimate some model and if exchange rate deviates from model predictions we would say it’s over or undervalued. For example, now outdated but still popular model for exchange rate determination is the monetary model of exchange rates. In this model exchange rate depends on ‘fundamentals’ such as price levels, money supply, velocity of money, real output and interest rate.

In such model we say exchange rate is overvalued if the actual observed exchange rate has a higher value than we would expect given the values of country’s fundamentals (price level, output, interest rates etc.).

An overvalued exchange rate implies that a countries currency is too high for the state of the economy. An overvalued exchange rate means that the countries exports will be relatively expensive and imports cheaper. An overvalued exchange rate tends to depress domestic demand and encourage spending on imports. -Tejvan Pettinger

https://www.economicshelp.org/blog/2882/currency/problems-of-overvalued-exchange-rate/

• Can you unpack this a little? What is meant by 'high for the state of the economy', for instance? – StatsScared Jan 27 at 19:47