BPEA | Fall 2008

The Real Exchange Rate and Economic Growth

Dani Rodrik
Dani Rodrik Headshot
Dani Rodrik Ford Foundation Professor of International Political Economy, John F. Kennedy School of Government - Harvard University

Fall 2008

I show that undervaluation of the currency (a high real
exchange rate) stimulates economic growth. This is true particularly for developing
countries. This finding is robust to using different measures of the real
exchange rate and different estimation techniques. I also provide some evidence
that the operative channel is the size of the tradable sector (especially
industry). These results suggest that tradables suffer disproportionately from
the government or market failures that keep poor countries from converging
toward countries with higher incomes. I present two categories of explanations
for why this may be so, the first focusing on institutional weaknesses, and the
second on product-market failures. A formal model elucidates the linkages
between the real exchange rate and the rate of economic growth.