Abstract
Empirical studies outline developing countries’ experience economic growth through an undervalued exchange rate and that exchange rate overvaluations have negative long term effects on economic growth. This paper examined the impact of exchange rate movements as well as exchange rate misalignments on economic growth for the Trinidad and Tobago economy over the period 1960 to 2016. We find statistically significant evidence that both exchange rate appreciation and misalignments impact negatively on economic growth in the T&T economy. Drilling deeper, we find interestingly that there exist no non-linear effects of exchange rate misalignments on growth. Specifically, we find statistically significant evidence that both overvaluations and under valuations hamper economic growth in the Trinidad and Tobago economy. We attribute this to T&T’s small and underdeveloped manufacturing sector that tends to be overlooked on account of its energy resources, in addition to the fact that its manufacturing sector is highly import oriented. A major policy recommendation would be for the critical reassessment of the rules governing the Heritage and Stabilization Fund (HSF), as government expenditure was allowed to follow energy revenues due to its current limitations.
Highlights
Exchange rates powerfully affect cross-border economic transactions, according to Frieden (2008).“Trade, investment, finance, tourism, migration, and more are inextricably linked to and influenced by international monetary policy”, see Frieden (2008, p. 344)
The paper examines the impact of exchange rate misalignments on economic growth for the Trinidad and Tobago economy. We examine whether these effects are linear or non-linear; by testing the theoretical and empirical notion that an overvaluation is harmful to economic growth whilst an undervaluation is beneficial to economic growth
McLeod and Mileva (2011) were able to show through a two-sector open economy growth model that a combination of “learning by doing” in the traded goods sector along with a weak real effective exchange rate (REER) which acts as a policy lever that moves workers into traded goods production faster, can lead to a surge in total factor productivity (TFP) growth6
Summary
Exchange rates powerfully affect cross-border economic transactions, according to Frieden (2008). Overvaluations have been empirically found to have a negative impact on growth in the literature Though this seems to be a long way off for the Trinidad and Tobago economy given its relatively large buffer of foreign reserves and a still healthy position of 9.7 months of import cover as of 2017, this can dissipate in the absence of greater exchange rate flexibility as noted by the IMF. From our review of the literature, to the best of our knowledge, this is the first empirical paper that addresses the impact of exchange rate misalignments (both overvaluations and undervaluations) on economic growth on such a country classification.
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