The Real Exchange Rate, Mercantilism and the Learning by Doing Externality

Joshua Aizenman () and Jaewoo Lee ()

No 13853, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper examines the degree to which the learning by doing externality [LBD] calls for an undervalued exchange rate, a policy suggested by recent empirical studies which concluded that mildly undervalued real exchange rate may enhance growth. We obtain mixed results. For an economy where LBD externality operates in the traded sector, real exchange rate undervaluation may be used in order to internalize this externality, if the LBD calls for subsidizing employment in the traded sector. Yet, we also find that these results are not robust to changes in the nature of the LBD externality. If the LBD externality is embodied in aggregate investment, the optimal policy calls for subsidizing the cost of capital in the traded sector, and there is no room for undervalued exchange rate policy. In addition, a deliberate undervaluation by means of hoarding reserves may backfire if the needed sterilization would increase the cost of investment in the traded sector.

JEL-codes: F13 F15 F31 F43 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-ifn and nep-opm
Date: 2008-03
Note: ITI
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