Revisiting real exchange rate misalignment and economic growth nexus: a Markov-switching approach

ABSTRACT

In this study, we examine whether the impact of the real exchange rate (RER) misalignment on the growth is consistent when the economic condition of the country is different. We use a Markov-switching regime model to, respectively, explore whether there are asymmetric effects of RER misalignments on the economic growth of 10 Asian countries. We find that the impact of the RER misalignment on the growth is mixed and asymmetric depending on the economic status of the country. An RER undervaluation does not necessarily help economic growth, and an overvaluation does not necessarily hamper economic growth. When economic conditions are volatile, the effect of the RER misalignment on economic growth is insignificant. However, the RER misalignment is more likely to have an impact on the economic growth when the economy is in a tranquil state.

KEYWORDS:

• real exchange rate misalignment
• economic growth
• Markov-switching regime model
• Real Exchange Rate

JEL CLASSIFICATION:

• F31
• F43
• O24

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ Eichengreen (2008) offers a review on the literature on the nexus between RER and economic growth, and Habib, Mileva, and Stracca (2017) also provide an excellent review for more recent studies.

² BIS explains how they calculate the REER and provides the trade weight used in the calculation on their website.

³ As what has been discussed in Daude, Levy-Yeyati, and Nagengast (2016), there is no uncontroversial way to define an equilibrium level of the real exchange rate. Thus, in this paper we choose the standard fundamentals to estimate the equilibrium RER.: