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Exchange rate misalignments, growth, and institutions

Author

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  • Jaromír Baxa

    (Charles University
    Czech Academy of Sciences)

  • Michal Paulus

    (Charles University)

Abstract

This article revisits the relationship between economic growth and exchange rate misalignments. We aim to test whether undervaluation's impact on growth depends on institutional quality, as suggested in the previous literature. In our analysis, we focus on recent decades characterized by globalization. We use the framework of cross-country growth regressions estimated using the recently developed two-stage instrumental variable method, which allows accounting for cross sectional dependence. In addition, we use external instruments to address the potential endogeneity between economic growth and undervaluation. Our results confirm the positive relationship between undervaluation and growth across all income groups from low-income to high-income countries. The role of institutions in the transmission of undervaluation on growth appears consistently only among lower-middle-income countries. Therefore, while our results point to the positive effects of undervaluation, the support for the hope that countries can successfully compensate for poor institutional quality via the undervaluation of currencies is weaker and limited to specific stages of economic development.

Suggested Citation

  • Jaromír Baxa & Michal Paulus, 2024. "Exchange rate misalignments, growth, and institutions," Empirical Economics, Springer, vol. 67(4), pages 1705-1799, October.
    • Handle: RePEc:spr:empeco:v:67:y:2024:i:4:d:10.1007_s00181-024-02600-4
    DOI: 10.1007/s00181-024-02600-4
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    Cited by:

    1. Abdul Jalil, 2021. "Exchange Rate Policy Must Seek Undervaluation!," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 60(1), pages 85-91.

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    More about this item

    Keywords

    Exchange rate misalignments; Undervaluation; Economic growth; Institutions; Corruption;
    All these keywords.

    JEL classification:

    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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