Abstract:
The importance of exchange rate in an economy can be seen in the various policies implemented
to manage its level and evolution on a daily basis. A large body of literature has analyzed
the impact of exchange rate, or its deviation from certain equilibrium, on economic growth.
The correlation between exchange rate undervaluation and economic growth is among the most
investigated open macroeconomics topics. However, the question is ”does exchange rate undervaluation
truly growth enhancing? The purpose of this study is to analyze the impact of
exchange rate misalignment on economic growth for a sample of emerging economies from 1970
to 2014 using a panel smooth transition regression (PSTR) vector error correction model. Besides,
we provide a Granger causality test conducted in a non-linear framework. We find that a
rise in misalignment increases significantly output in the short-run when currencies are close to
equilibrium. When they are highly misaligned, the impact on growth is reduced. However, no
significant impact of output on misalignment was found in the short-run. We provide evidence
that misalignment Granger causes output at any given level of misalignment both in the short
and long-run. A weaker Granger causality was found between output and misalignment. This
raises some important implications. Although emerging economies can use undervaluation as a
growth strategy, the benefits are smaller the larger the undervaluation. There is therefore an
incentive to keep exchange rates closer to their equilibrium
