Exchange Rate Policy and Economic Development

Abstract

The maintenance of overvalued exchange rates has become almost standard policy in the underdeveloped countries. Just as domestic inflationary pressures invariably accompany major development efforts, so too do balance of payments difficulties. Rather than meet these problems with exchange depreciation, most poor countries have attempted to eliminate their adverse payments balance by imposing quantitative trade restrictions. They advance three main supporting arguments in adopting this alternative. First, overvaluation coupled with quantitative controls stimulates diversification in the structure of production. Secondly, depreciation of an overvalued currency causes a rise in domestic prices and thus merely aggravates the problem of controlling inflation. Thirdly, an overvalued rate enables the country to improve its income terms of trade.