A study on the determinants of the real exchange rate misalignments

Abstract

ABSTRACT Departing from the literature that established a positive relation between exchange rate undervaluation and economic growth, this paper explores the causes of persistent undervaluation (or overvaluation) of the exchange rate. We first discuss the variables that could explain persistent misalignment of the real exchange rate on a theoretical basis. Then we present empirical evidence of the relation between those variables in selected country groups. We proceed by employing econometric models to estimate the overvaluation or undervaluation based on a panel dataset comprising 119 countries from 1980 to 2022. Our findings indicate that countries with higher savings rates, government debt, and openness to trade tend to exhibit a more undervalued currency, the opposite happening to countries with better terms of trade and larger capital inflows.

Keywords

• Real exchange rate
• misalignments
• undervaluation
• growth