The Real Exchange Rate, the Real Wage, and Growth: A Formal Analysis of the “Development Channel”

Traditional macroeconomic analysis suggests that a higher real exchange rate (RER) has a positive effect on the balance of payments constrained level of economic activity provided, of course, that the Marshall-Lerner condition is fulfilled. This is the traditional “macroeconomic channel”: a higher RER enhances competitiveness of exports and raises import prices thus strengthening the competitiveness of import-competing local producers. In so doing it improves the trade balance and the level of output corresponding to a given trade deficit. A recent, mostly empirical, literature suggests the existence of a growth, rather than level, effect on output of a higher RER. Indeed, the relationship between the RER and the rate of economic growth has been receiving a great deal of attention in recent times after the extraordinarily high growth rates achieved by countries that have deliberately undervalued their RERs and the slow growth rates experienced by a large number of countries with overvalued exchange rates. The first case is illustrated with the experience of China (see Razmi, Rapetti, and Skott, 2012) and, in the Latin American context and to a lesser extent, of Argentina, while the second case can be illustrated with the experience of Mexico (see Blecker, 2009; Ibarra, 2010; Moreno-Brid and Ros, 2009).