Real exchange rate misalignment and economic growth in Malaysia

Abstract

PurposeThe purpose of this study is to examine real exchange rate misalignment and economic growth in Malaysia.Design/methodology/approachThe result of the autoregressive distributed lag (ARDL) approach and the generalized forecast error variance decomposition.FindingsThe result of the ARDL approach shows an increase in the real interest rate differential, productivity differential, the real oil price or reserve differential will lead to an appreciation of the real exchange rate in the long run. The result of the generalized forecast error variance decomposition shows that the real interest rate differential, productivity differential, the real oil price, and reserve differential are generally important to the real exchange rate determination. Moreover, the result of the ARDL approach shows that an increase in real exchange rate misalignment will lead to a decrease in economic growth. More specifically, devaluation will promote economic growth and appreciation will hurt economic growth. Exchange rate can be a policy variable to influence economic growth. Real exchange rate misalignment should be avoided to enable the allocation of resources in the economy according to fundamentals.Originality/valueA managed floating exchange rate regime could be a choice of exchange rate regime in other developing countries to achieve rapid economic growth.