Do currency undervaluations affect the impact of inflation on growth? |
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| Institution: | 1. Research Department, State Bank of Pakistan, Pakistan;2. Management Sciences Department, Shaheed Zulfikar Ali Bhutto Institute of Science and Technology (SZABIST), Pakistan;3. School of Economics and Finance, Massey University, New Zealand;4. Department of International Trade and Marketing, Gediz University, Izmir, Turkey;5. Monetary Policy Department, State Bank of Pakistan, Karachi, Pakistan;1. Department of Business Administration, Athens University of Economics and Business, 76 Patission Street, GR-10434, Athens, Greece;2. IPAG Business School, 184 Boulevard Saint-Germain, FR-75006, Paris, France;3. Centre for Planning and Economic Research, 11 Amerikis Street, GR-10672, Athens, Greece;1. WHU - Otto Beisheim School of Management, Burgplatz 2, 56179, Vallendar, Germany;2. EBS Business School, Burgstraße 5, 65375, Oestrich-Winkel, Germany |
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| Abstract: | In this paper, we investigate how the level of currency undervaluations affects the effect of inflation on growth in a sample of 62 countries over the 1980–2015 period. While previous studies find a positive effect of an undervalued currency, we show that higher currency undervaluations reinforce the contractionary effect of inflation on growth. As an undervalued currency is associated with supplementary inflation pressures arising from a cost-push inflation phenomenon and economy overheating, growth is thus penalized. This result is shown to be robust to the exclusion of currency crises episodes from our sample, and dependent of the development level of countries. Specifically, it holds in the case of emerging countries, but not for developing economies. Consequently, policies based on undervaluations should not be encouraged for emerging economies as they tend to reinforce the contractionary effect of inflation on growth. |
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| Keywords: | Currency undervaluation Inflation Growth GMM BMA F41 O47 E31 |
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