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Undervaluation, Financial Development, and Economic Growth

Author

Listed:
  • Jingxian Zou

    (National School of Development, Peking University)

  • Yaqi Wang

    (USchool of Finance, Central University of Finance and Economics)

Abstract

This paper analyzes the effect of undervaluation on economic growth in the presence of borrowing constraints. Based on a two-sector, small open-economy model, we show that undervaluation can promote economic growth by partly correcting distortions in financial markets through the channels of increased within-sector productivity and the relative share of the tradable sector in an economy. Such an effect is magnified amid tight borrowing constraints. We empirically test the theoretical conclusions using cross-economy data for the period 1980–2011. For economies whose level of financial development lies at the 25th percentile of our sample, a 50% undervaluation can boost the economic growth rate by 0.3 percentage points. There is an additional 0.045 percentage point increase in economic growth with a 10% decline in the financial development measure.

Suggested Citation

  • Jingxian Zou & Yaqi Wang, 2017. "Undervaluation, Financial Development, and Economic Growth," Asian Development Review, MIT Press, vol. 34(1), pages 116-143, March.
    • Handle: RePEc:tpr:adbadr:v:34:y:2017:i:1:p:116-143
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    File URL: http://www.mitpressjournals.org/doi/pdf/10.1162/ADEV_a_00083
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    Citations

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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.
    2. IWASAKI, Ichiro & ONO, Shigeki, 2023. "Economic Development and the Finance-Growth Nexus : A Meta-Analytic Approach," CEI Working Paper Series 2023-06, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University.

    More about this item

    Keywords

    economic growth; financial development; undervaluation;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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