Real exchange rate, demand growth and labour productivity: a growth model of cumulative and circular causation

Abstract

This chapter develops a Kaldorian growth model of cumulative and circular causation to study the association between real exchange rate and long-run growth. The innovation is to consider the real exchange rate as an explanatory variable of labour productivity growth, in addition to the Kaldor-Verdoorn mechanism. The argument is that a competitive real exchange rate can induce capital accumulation and technological progress, which impacts labour productivity. The chapter's findings suggest that a competitive real exchange rate is associated with a greater (lower) long-run growth, in economies under a profit- (wage-)led regime of demand and capital accumulation. Such effect occurs via the cumulative and circular causation induced by the faster (slower) pace of demand growth, reinforced by the greater (lower) capital accumulation, and technological progress, induced by a competitive real exchange rate. Lastly, this study provides some empirical evidence that a competitive real exchange rate spurs the labour productivity growth rate of OECD countries.