Working Paper: NBER ID: w13853
Authors: Joshua Aizenman; Jaewoo Lee
Abstract: This paper examines the degree to which the learning by doing externality [LBD] calls for an undervalued exchange rate, a policy suggested by recent empirical studies which concluded that mildly undervalued real exchange rate may enhance growth. We obtain mixed results. For an economy where LBD externality operates in the traded sector, real exchange rate undervaluation may be used in order to internalize this externality, if the LBD calls for subsidizing employment in the traded sector. Yet, we also find that these results are not robust to changes in the nature of the LBD externality. If the LBD externality is embodied in aggregate investment, the optimal policy calls for subsidizing the cost of capital in the traded sector, and there is no room for undervalued exchange rate policy. In addition, a deliberate undervaluation by means of hoarding reserves may backfire if the needed sterilization would increase the cost of investment in the traded sector.
Keywords: No keywords provided
JEL Codes: F13; F15; F31; F43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| LBD externality (D62) | undervalued exchange rate policy (F31) |
| undervalued exchange rate policy (F31) | subsidizing employment in traded sector (F16) |
| LBD externality embodied in aggregate investment (E22) | subsidizing capital costs (G31) |
| hoarding reserves (D14) | increased sterilization costs (Q52) |
| increased sterilization costs (Q52) | adverse effect on investment in traded sector (F69) |