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The Real Exchange Rate as an Instrument of Development Policy

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Author Info
Arslan Razmi () (University of Massachusetts Amherst)
Martin Rapetti () (University of Massachusetts Amherst)
Peter Skott () (University of Massachusetts Amherst)

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Abstract

Growth is endogenous in small open economies with substantial hidden or open unemployment, even under constant returns to scale. Growth promoting policies, however, have implications for the balance of trade, and two instruments are needed in order to achieve targets for both the growth rate and the balance of trade. The real exchange rate can serve as one of those instruments. Distributional conflict imposes constraints on real exchange rate policies, but in LDCs the main exchange-rate related distributional conflict may be over the sectoral distribution of profits, rather than the real wage. This paper develops a model along these lines and presents empirical support for the hypothesis that real exchange rate undervaluations are a useful instrument for the pursuit of accumulation and growth in low income countries. JEL Categories: F43, O11, O41

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Paper provided by University of Massachusetts Amherst, Department of Economics in its series Working Papers with number 2009-07.

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Date of creation: Jul 2009
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Handle: RePEc:ums:papers:2009-07

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Keywords: Real exchange rates; underemployment; capital accumulation; investment; growth.;

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  2. Stanley Fischer, 1993. "The Role of Macroeconomic Factors in Growth," NBER Working Papers 4565, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Eswar S. Prasad & Raghuram G. Rajan & Arvind Subramanian, 2007. "Foreign Capital and Economic Growth," NBER Working Papers 13619, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Simon Johnson & Jonathan David Ostry & Arvind Subramanian, 2007. "The Prospects for Sustained Growth in Africa: Benchmarking the Constraints," IMF Working Papers 07/52, International Monetary Fund. [Downloadable!]
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  5. Alesina, Alberto & Perotti, Roberto, 1996. "Income distribution, political instability, and investment," European Economic Review, Elsevier, vol. 40(6), pages 1203-1228, June. [Downloadable!] (restricted)
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  6. Ros, Jaime & Skott, Peter, 1998. "Dynamic Effects of Trade Liberalization and Currency Overvaluation under Conditions of Increasing Returns," The Manchester School of Economic & Social Studies, Blackwell Publishing, vol. 66(4), pages 466-89, September.
  7. Wang, Lili & Szirmai, Adam, 2008. "Regional Capital Inputs in Chinese Industry and Manufacturing, 1978-2003," GGDC Research Memorandum GD-99, Groningen Growth and Development Centre, University of Groningen. [Downloadable!]
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  8. Krugman, Paul, 1987. "The narrow moving band, the Dutch disease, and the competitive consequences of Mrs. Thatcher : Notes on trade in the presence of dynamic scale economies," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 41-55, October. [Downloadable!] (restricted)
  9. Bahmani-Oskooee, Mohsen & Niroomand, Farhang, 1998. "Long-run price elasticities and the Marshall-Lerner condition revisited," Economics Letters, Elsevier, vol. 61(1), pages 101-109, October. [Downloadable!] (restricted)
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