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On the link between real exchange rate misalignment and growth: theory and empirical evidence

Diallo, Ibrahima Amadou (2015): On the link between real exchange rate misalignment and growth: theory and empirical evidence.

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Abstract

This paper analyzes the effect of real exchange rate (RER) on economic growth both theoretically and empirically. The first part builds an endogenous growth model which illustrates that an RER appreciation reduces the growth rate in the centralized and decentralized economies. Additionally, the model shows that taxes have a negative effect on growth. The second part employs the new Cross-Sectionally Augmented Distributed Lag Estimator to empirically study the impact of RER misalignment on economic growth. The results demonstrate that RER misalignment acts harmfully on growth. Thus corroborating what we found theoretically. The empirical findings also confirm the adverse effect of taxes on growth. The negative impact of RER misalignment on growth are maintained when we use alternative measurements of RER misalignment and subsamples of developed and developing countries. Finally, we discovered that very large misalignments have even greater damaging impacts on growth.

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