Economic growth and deviations from the equilibrium exchange rate

Abstract

This paper investigates the heterogeneous relationship between per capita economic growth rate and the deviations from the equilibrium exchange rate, as different types of countries might exhibit different dynamics, and macro variables cannot easily capture region-specific heterogeneity. Using annual data for 103 countries during the 1996–2016 period and applying the novel grouped fixed effects estimator developed by Bonhomme and Manresa (2015), the empirical analysis presented in this paper indicates that such relationship varies across groups of countries, endogenously identifying six groups with different time patterns and a different estimated impact (ranging from −0.0643 to −0.0014). Overall, our findings imply that deviations from the equilibrium exchange rate reduce the pace of real economic growth, regardless of income category, documenting that the effects are most pronounced for advanced economies, followed by low income developing countries and, finally, for emerging economies Our results also suggest that fixed and intermediate exchange rate regimes severely slow down economic growth.