Real exchange rate policies for economic development

•A stable and competitive RER policy may promote economic development.•Optimality also requires a system of effectively multiple RERs.•Industrial policies may increase the elasticity of the supply of tradable goods to the RER.•Regulation of capital flows is an essential element of RER policies.•And...

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Bibliographic Details
Published in:World development 2018-10, Vol.110, p.51-62
Main Authors: Guzman, Martin, Ocampo, Jose Antonio, Stiglitz, Joseph E.
Format: Article
Language:English
Subjects:
Aggregate supply
Capital
Capital account policies
Capital movement
Comparative advantage
Dynamic comparative advantage
Economic analysis
Economic development
Economic growth
Economic policy
Elasticity
Exchange rate policy
Foreign exchange
Foreign exchange markets
Foreign exchange rates
Industrial policies
Industrial policy
Investments
Learning spillovers
Markets
Policies
Real exchange rate
Regulation
Spillover effect
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Summary:•A stable and competitive RER policy may promote economic development.•Optimality also requires a system of effectively multiple RERs.•Industrial policies may increase the elasticity of the supply of tradable goods to the RER.•Regulation of capital flows is an essential element of RER policies.•And so is interventions in foreign exchange markets. This paper analyzes the role of real exchange rate (RER) policies in promoting economic development. Markets provide a suboptimal amount of investment in sectors characterized by learning spillovers. We show that a stable and competitive RER policy may correct for this externality and other related market failures. The resulting development of these sectors leads to overall faster economic growth. A system of effectively multiple exchange rates is required when spillovers across different tradable sectors differ. The impact of RER policies is increased when they are complemented by traditional industrial policies that increase the elasticity of the aggregate supply to the RER. Among the instruments required to implement a stable and competitive RER are interventions in the foreign exchange market and regulation of capital flows. We also discuss the trade-offs associated with alternative stable and competitive RER policies and the relationship between the use of exchange rate policies for macro-stability and for development.
ISSN:0305-750X
1873-5991
DOI:10.1016/j.worlddev.2018.05.017