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Should developing countries undervalue their currencies?

Author

Listed:
  • Marcel Schroder
Abstract
The Washington Consensus emphasizes the economic costs of real exchange rate distortions. However, a sizable recent empirical literature finds that undervalued real exchange rates help countries to achieve faster economic growth. This paper shows that recent findings are driven by inappropriate homogeneity assumptions on cross-country long-run real exchange rate behavior and/or growth regression misspecification. When these problems are redressed, the empirical results for a sample of 63 developing countries suggest that deviations of the real exchange rate in either direction from the value that is consistent with external and internal equilibrium reduces economic growth. Deviations from Balassa-Samuelson adjusted purchasing power parity on the other hand do not seem to matter for growth performance. The real exchange rate should thus be consistent with external and internal balance irrespective of implied purchasing power parity benchmarks.

Suggested Citation

  • Marcel Schroder, 2013. "Should developing countries undervalue their currencies?," Departmental Working Papers 2013-12, The Australian National University, Arndt-Corden Department of Economics.
    • Handle: RePEc:pas:papers:2013-12
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    File URL: https://crawford.anu.edu.au/acde/publications/publish/papers/wp2013/wp_econ_2013_12.pdf
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    More about this item

    Keywords

    Real exchange rate misalignment; Undervaluation; Economic growth;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development

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