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Macroeconomic Policy Coordination in a Competitive Real Exchange Rate Strategy for Development

  • Martin Rapetti

    ()

    (University of Massachusetts Amherst)

Recent research has documented a positive relationship between real exchange rate (RER) levels and economic growth. The literature has interpreted this correlation as causality running from RER levels to growth rates; i.e., higher, undervalued, more competitive RERs tend to favor growth. Little effort has been made, however, on the analysis of the policy instruments required to implement a successful competitive RER strategy. An exchange rate policy targeting a permanent change in the RER may run into difficulties: it is well documented that nominal and real exchange rate movements are correlated almost one for one in the short run but such co-movement slowly vanishes in the long run. Targeting instead a transitory RER undervaluation can have long-lasting effects on economic performance if RER competitiveness is stable and durable enough to provide incentives for tradable activities to expand. The ability to provide such an environment may be beyond the scope of exchange rate policy. This paper aims to shed light on the complementary policies that facilitate the success of an exchange rate policy that temporarily increases competitiveness. A formal model inspired by Ros and Skott (1998) is developed to analyze these issues. The main conclusion is that an exchange rate depreciation would more likely trigger an acceleration of growth if it is simultaneously implemented with domestic demand management policies that prevent non-tradables price inflation and wage management policies that coordinate wage increases with tradable productivity growth. JEL Categories: O11, E61

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Paper provided by University of Massachusetts Amherst, Department of Economics in its series UMASS Amherst Economics Working Papers with number 2011-09.

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Date of creation: Jun 2011
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Handle: RePEc:ums:papers:2011-09
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  1. Jeffrey A. Frankel, 2005. "Contractionary Currency Crashes in Developing Countries," NBER Working Papers 11508, National Bureau of Economic Research, Inc.
  2. Taylor, Alan M. & Taylor, Mark P, 2004. "The Purchasing Power Parity Debate," CEPR Discussion Papers 4495, C.E.P.R. Discussion Papers.
  3. Alvaro Aguirre & César Calderón, 2005. "Real Exchange Rate Misalignments and Economic Performance," Working Papers Central Bank of Chile 316, Central Bank of Chile.
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  8. Paulo Gala, 2008. "Real exchange rate levels and economic development: theoretical analysis and econometric evidence," Cambridge Journal of Economics, Oxford University Press, vol. 32(2), pages 273-288, March.
  9. Arslan Razmi & Martin Rapetti & Peter Skott, 2011. "The Real Exchange Rate and Economic Development," UMASS Amherst Economics Working Papers 2011-08, University of Massachusetts Amherst, Department of Economics.
  10. 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, University of Manchester, vol. 66(4), pages 466-89, September.
  11. Roberto Frenkel & Martin Rapetti, 2010. "A Concise History of Exchange Rate Regimes in Latin America," UMASS Amherst Economics Working Papers 2010-01, University of Massachusetts Amherst, Department of Economics.
  12. Taylor, Mark P & Peel, David A & Sarno, Lucio, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Toward a Solution to the Purchasing Power Parity Puzzles," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 1015-42, November.
  13. Gabriel Porcile & Gilberto Tadeu Lima, 2010. "Real exchange rate and elasticity of labour supply in a balance-of-payments-constrained macrodynamics," Cambridge Journal of Economics, Oxford University Press, vol. 34(6), pages 1019-1039.
  14. Rees, Albert, 1993. "The Role of Fairness in Wage Determination," Journal of Labor Economics, University of Chicago Press, vol. 11(1), pages 243-52, January.
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