Abstract
Despite the large body of work that exists on the impact of exchange rate undervaluation on economic growth, only a mere literature focuses on the potential transmission mechanisms. There are autho...
Highlights
There was a regained interest on the exchange rate undervaluation strategy pursued by most emerging economies, especially after the recent 2007 financial crisis, due to the increase in global imbalances
Despite the large body of work that exists on the impact of exchange rate undervaluation on economic growth, only a mere literature focuses on the potential transmission mechanisms
Exchange rate should not matter for economic performance in a perfectly competitive environment, as changes in nominal exchange rate cannot have an impact on real prices (Mao & Yao, 2015), exchange rate distortion causing an undervaluation may lead to faster growth
Summary
There was a regained interest on the exchange rate undervaluation strategy pursued by most emerging economies, especially after the recent 2007 financial crisis, due to the increase in global imbalances. The effects of exchange rate undervaluation on growth operate partially through the change in the relative size of the tradables Another investigated channel looks at the impact of undervaluation on growth through an increase in factor productivity. McLeod and Mileva (2011) analyse the impact of real exchange rate (RER) changes on total factor productivity (TFP) growth for a panel of 58 developing countries between 1975 and 2004 They find a strong support for a positive causal correlation between weak exchange rate and higher TFP growth. An undervaluation is a second best mechanism for alleviating institutional weakness According to this claim, the relative size of the tradables to non-tradables will be positively correlated to a measure of IQ as the worse institution will impose a relatively higher “tax” on tradables.
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