Reconciling Contrasting Views on the Growth Effect of Currency Undervaluations

This paper provides an in-depth analysis of the link between exchange rate misalignments and economic growth for a large sample of 170 countries over the 1973-2019 period. We rely on new cross-country data on multilateral currency misalignments and cross-quantile regressions to demonstrate that the seemingly divergent views of the Washington Consensus and the export-led growth theory on the role of currency undervaluations in promoting economic growth can be reconciled. Although any significant departures from the equilibrium exchange rate levels are found undesirable, we show that undervaluations are more likely to stimulate economic growth in developing countries. However, this positive impact is observed only up to certain thresholds of development level and currency undervaluation. Consequently, strategies in the poorest countries that systematically undervalue currencies in real terms to foster growth should be carefully tailored, as they raise the risk for these economies of switching from a positive to a less favorable growth regime, depending on both their specific wealth level and the extent of their currency undervaluation.