Undervaluation, Financial Development, and Economic Growth

Jingxian Zou and Yaqi Wang
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Jingxian Zou: National School of Development, Peking University
Yaqi Wang: USchool of Finance, Central University of Finance and Economics

Asian Development Review, 2017, vol. 34, issue 1, 116-143

Abstract: This paper analyzes the effect of undervaluation on economic growth in the presence of borrowing constraints. Based on a two-sector, small open-economy model, we show that undervaluation can promote economic growth by partly correcting distortions in financial markets through the channels of increased within-sector productivity and the relative share of the tradable sector in an economy. Such an effect is magnified amid tight borrowing constraints. We empirically test the theoretical conclusions using cross-economy data for the period 1980–2011. For economies whose level of financial development lies at the 25th percentile of our sample, a 50% undervaluation can boost the economic growth rate by 0.3 percentage points. There is an additional 0.045 percentage point increase in economic growth with a 10% decline in the financial development measure.

Keywords: economic growth; financial development; undervaluation (search for similar items in EconPapers)
JEL-codes: F31 F36 F43 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:tpr:adbadr:v:34:y:2017:i:1:p:116-143

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