Exchange Rate Misalignment and Growth: A Myth?

Abstract

The impact of real exchange rate movements on GDP growth is a hotly debated issue both in policy and academic circles. In this paper we provide evidence suggesting that the association between exchange rate misalignment and growth for a broad panel of countries is very weak. Controlling for country …xed e¤ects, time e¤ects and initial GDP, a more depreciated currency is associated with higher growth if one does not exclude outliers. However, this positive association always vanishes after controling for the savings rate. Importantly, this applies for both a large panel of countries and for the emerging economies subsample.JEL Codes: F31, F43, O47

Revisiting the real exchange rate misalignment‐economic growth nexus via the across‐sector misallocation channel

“…, consistently with the standard conditional convergence hypothesis (Barro & Sala-i-Martin, 2004), and gross domestic savings (as a percentage of GDP, sourced from IMF WEO; savrate i,t ). As well as being a relevant driver in standard growth models, the inclusion of the latter variable also serves the purpose of testing the robustness of our results; indeed, as highlighted by Woodford (2009) and Gonçalves and Rodrigues (2017), the savings rate may be a potentially confounding factor in the estimation of the REER misalignment-economic growth link, in that it is positively related to economic growth and negatively correlated to the REER. The expected sign of the coefficients attached to these two control variables is negative for the former and positive for the latter.…”

“…Without focusing on specific channels, Gala (2008), Di Nino et al (2013) and Béreau et al (2012) find evidence of a direct, positive effect of undervaluations on economic performance in various countries in their developing phase. Gonçalves and Rodrigues (2017) instead finds no significant direct relationship between REER disequilibria and economic growth, once GDP and REER outliers are removed from the sample and when appropriate control variables (namely, the savings rate) are accounted for. These studies however suffer from the limitation of not assessing the channels at play, issue which is instead addressed by this article.…”

“…This "contemporaneous" (i.e. within five-year periods) relationship between the dependent and explanatory variables (with the exception of GDP per capita, appraised at the beginning of each period) is similarly investigated, for example, by Rodrik (2008), Schröder (2013) and Gonçalves and Rodrigues (2017). 20 SGMM has also been employed in a similar context in, for example, Aguirre and Calderón (2005), Gala (2008), Schröder (2013) and Grekou (2018).…”

“…In order to compute real exchange rate (RER) misalignments, Rodrik (2008) and subsequent empirical studies (Di Nino et al, 2013; Gonçalves & Rodrigues, 2017; Habib et al, 2017; Rajan & Subramanian, 2011) regress the RER relative to the US dollar of a panel of countries against per capita income (capturing the Balassa‐Samuelson effect) and time fixed effects; they then use the residual as a measure of misalignment of the local currency.…”

“…This “contemporaneous” (i.e. within five‐year periods) relationship between the dependent and explanatory variables (with the exception of GDP per capita, appraised at the beginning of each period) is similarly investigated, for example, by Rodrik (2008), Schröder (2013) and Gonçalves and Rodrigues (2017).…”