Endogenous elasticities and the impact of the real exchange rate on structural economic dynamics

Abstract

This paper aims at showing that the level of the real exchange rate affects the rate of economic growth. More specifically, we extend the model developed by Araujo and Lima (2007) to derive a balance-of-payments equilibrium growth rate analogous to Thirlwall’s Law based on a Pasinettian multi-sector macrodynamic framework in which income elasticities are endogenous to the level of the real exchange. Furthermore, the model is built to relate growth, the real exchange rate and sectoral heterogeneity. From a cumulative causation perspective, we thus demonstrate the effect of the level of real exchange rates on the generation of technological progress, and how these rates also impact the growth of the whole economy via a balance-of-payments constrained approach. Finally, we show that an undervalued real exchange rate has positive effects on economic growth in developing countries.