Real Exchange Rate Misalignment and Economic Growth: An Update

Bulent Ulasan

Working Papers from Research and Monetary Policy Department, Central Bank of the Republic of Turkey

Abstract: This paper empirically examines the relationship between real exchange rate misalignment and economic growth by using an updated data set over the sample period 1990-2014 for a large number of countries. Our findings indicate that the measure of real exchange rate misalignment is positively associated with economic growth for the low and middle-income countries whereas no significant relationship between these two for richer countries, implying the more overvalued the currency is over the long run, the lower the long-run growth rate of per capita income in developing countries. A plausible interpretation of this finding is that following the financial liberalization, large capital inflows and lending boom lead to appreciation of real exchange rates in the majority of developing countries. Prolonged real appreciation may result in lower long-run growth because of two channels: first, by changing resource allocation in favour of nontraded-goods sector it may reduce the long-term growth prospects; and second, by promoting private debt denominated in foreign currency it makes economy more vulnerable to external shocks, that is due to contractionary balance-sheet effects, a sudden and sharp real depreciation, which often happens in the boost cycle, may have a negative effect on output and growth.

Keywords: Economic growth; Real exchange rate; Cross-country growth regression (search for similar items in EconPapers)
JEL-codes: C31 F31 F43 O11 O41 O47 (search for similar items in EconPapers)
Date: 2018
New Economics Papers: this item is included in nep-gro and nep-opm
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:tcb:wpaper:1819

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