In this context, the restriction on the long-run growth is given by the condition of equilibrium in the balance of payments which gives rise to so-called "Thirlwall Law" according to which the growth rate consistent with equilibrium in the balance of payments is equal the ratio of the income elasticity of exports and income elasticity of imports multiplied by the growth rate of world income.
Thus, the domestic growth rate will be equal to the growth rate of exports divided by the income elasticity of imports, what characterizes a growth regime of export-led type. In this context, the occurrence of catching-up requires that the ratio of these elasticities are greater than one; which requires, in turn, a diversified production structure and firms that are operating fairly close to the technological frontier.
Until recently, the literature of demand-led growth downplayed the existence of a relationship between the income elasticities of imports and exports and the level of real exchange rate. However, economists of the so-called Structuralist Development Macroeconomics has argued for the existence of a relationship between the level of the real exchange rate and the income elasticities of the Thirlwall model.
This article aims to analyze the recent behavior of the real exchange rate in Brazil, emphasizing its state of chronic overvaluation even after recent devaluations of nominal exchange rate. The relationship between the level and volatility of the real exchange rate and investment per worker in Brazil is analyzed using an econometric model with panel data for 30 sectors of manufacturing and extractive industry.
The empirical results support the hypothesis that the real exchange rate is a key variable in determining the capital accumulation and long-run growth path.
Finally, we conclude this paper by presenting a proposal for a macroeconomic policy framework to enable faster growth of the Brazilian economy and therefore the process of catching-up with respect to developed countries.
Recently, the exchange rate returned to the center of the Brazilian economic debate as a result of nominal devaluation arising from the anticipation of ending or at least reducing of monetary stimulus programs - so-called Quantitative Easing 3 - by the Federal Reserve, Fed. Indeed, as we see in Figure 1 , the interest rate of the year T-Notes begin to increase from April according to the expectation of "normalization" of monetary policy by the Federal Reserve.
In this context, we should ask what are the likely effects of the devaluation of the nominal exchange rate on the Brazilian economy. In particular, does the current level of exchange rate will allow the recovery of the Brazilian economy's competitiveness to be closer to the so-called industrial equilibrium, leveraging a greater dynamism of the industrial sector and, therefore, a more robust pace of economic growth 1 1 Regarding the relationship between the exchange rate overvaluation, loss of competitiveness and semi-stagnation of the Brazilian economy, see Oreiro To analyze the impact of the depreciation of the nominal exchange rate on the competitiveness of Brazilian industry we need to look at the effect on the real effective exchange rate for exports of manufactured products 2 2 This series is calculated by IPEA and is a measure of the competitiveness of Brazilian exports calculated by the weighted-average index of the purchasing power parity of 16 major trading partners of Brazil.
The weights used are the contributions of each partner of Brazilian exports of manufactured goods in This time series can be viewed in Figure 2.
As we can see in Figure 2 , the real effective exchange rate clear shows a trend to appreciation in the period from January to June Due to the impact of the international financial crisis, detonated from the bankruptcy of Lehman Brothers in September , the real effective exchange rate has suffered a rapid depreciation which, however, is reversed at the beginning of Ended the effects of the international financial crisis on the Brazilian economy observed a tendency towards stability of the real effective exchange rate until August , when it begins a process of depreciation, reaching in August a plateau near the prevailing in mid The return of the real effective exchange rate to the levels prevailing in mid means that the Brazilian manufacturing industry will retrieve its dynamism?
At first glance the answer would be yes, since in the period in which the real effective exchange rate was more depreciated, the manufacturing industry was more dynamic. A more careful analysis, however, leads us to be more pessimistic about the impact of the recent depreciation of the nominal exchange rate on the prospects of expansion of the production in manufacturing industry. As we can see in Figure 3 , the depreciation of the real effective exchange rate, which occurred from January , had no noticeable effect on the trend of the physical production in manufacturing industry, which continues to oscillate around a stationary level.
This means that the depreciation of the real exchange rate that has occurred so far has not been large enough to recover the competitiveness of Brazilian industry.
As we can see in Figure 4 , between January and December the real effective exchange rate deflated by nominal wage presented an appreciation of incredible This means, first of all, that the recent depreciation of the nominal exchange rate has had no noticeable effect on the relationship under consideration, thereby indicating that the competitiveness of the manufacturing industry remains unchanged.
Secondly, but no less important, the loss of competitiveness of the manufacturing industry, not only the trend towards appreciation of the exchange rate recorded since , but also the wage growth at a pace above labor productivity growth that occurred in this period.
What should be the real effective rate exchange rate to reestablish the competitiveness of Brazilian manufacturing industry? This simple exercise points to the fact that the recent depreciation of the nominal exchange rate is much lower than that required to restore the competitiveness of the manufacturing industry, a sine qua non condition for obtaining more robust growth rates for real GDP. It follows that while the government does not operate a profound change in macroeconomic matrix, which allows obtaining a more competitive exchange rate in the same time that keeping inflation in low and stable levels, the Brazilian economy will be doomed to get mediocre growth rates.
We will return to this issue. The hypothesis that not only the level of the real exchange rate, but also the volatility of the nominal exchange rate affects investment decisions was empirically supported by Darby et al. Thus, there would be two related channels acting on agent's investment decisions. The first, the traditional, which relates the real exchange rate to external competitiveness and economic activity: " The exchange rate is one of most important macroeconomic variables in the emerging and transition countries.
It affects inflation, exports, imports and economic activity " Edwards, , p. The second effect, relates the nominal exchange rate volatility to investment. Is was argued that the flow of new information on the market, in an environment of uncertainty, asymmetric information and incomplete markets, can both reduce the volatility but also increase it. This means that the relationship between volatility and increased uncertainty is not linear. This statement also does not mean that the elimination of exchange rate volatility automatically eliminates the uncertainty and therefore stimulates investment but yes, from certain level of volatility, uncertainty is so large that the agents simply choose to postpone their investment decisions.
Thus, the effect of volatility on the economy, in particular on industry, should not be homogeneous, being more significant for those with less monopoly power and lower technological intensity, i. Considering the data of the nominal bilateral exchange rate with the US dollar of the countries of G20 4 4 Argentina was excluded from the analysis due to lack of credibility of the exchange rate data.
As we all know, there is a huge difference between the value of official exchange rate and the one practiced in the real spot market.
Instead, it was considered the Chile which, although not part of the G20, is an important country in Latin America. The results are consistent with the empirical evidence cited by literature, so that exchange rate volatility is negatively correlated with economic growth, according to Figures 5 and 6. For calculating the volatility, in addition to the usual statistics measures, we used the VaR Value at Risk approach, derived from the probability distribution of asset, f w.
The choice of this measure stems from the international banking regulations established by Basel and followed by major central banks in the world. The risk associated of fluctuation of the exchange rate is part of the menu of concerns of regulatory requirements, so that the higher the risk exposure, the greater the capital requirements by banks and thus lower the capacity of lending and leverage.
Tables 1 , 2 and 3 and Figure 7 see the electronic edition of this journal summarize the results of calculation for both, parametric and non-parametric approach. From the data presented in Tables 2 and 3 see electronic edition , it is noted that the relative VaR exposure to foreign exchange rate in Brazil is quite high, which means high intensity in the exchange rate volatility and therefore high probability of maximum expected loss in portfolio of agents, particularly banks.
From: over-valued currency in A Dictionary of Economics ». Subjects: Social sciences — Economics. View all related items in Oxford Reference ». Search for: 'over-valued currency' in Oxford Reference ». All Rights Reserved. Under the terms of the licence agreement, an individual user may print out a PDF of a single entry from a reference work in OR for personal use for details see Privacy Policy and Legal Notice. Oxford Reference. As was previously discussed, PPP is unlikely to hold, even over very long periods, for a variety of very good reasons.
Also, there is no reason to think that current account balance represents some equilibrium or goal for an economy: countries can run trade deficits or surpluses for an extended period and suffer no ill effects.
Thus overvaluation or undervaluation of an exchange rate, for either reason PPP or current account balance should be thought of simply as something that happens. Of more interest is what it means when it happens. The PPP exchange rate is defined as the rate that equalizes the cost of a market basket of goods between two countries. If the U. This will also mean the exchange rate exceeds the ratio of market basket costs:. The left side LS of this expression represents the cost of a U.
The right side RS is the cost of the basket in Mexico also evaluated in pesos. Thus for the U. Of course, it also implies that goods and services are relatively cheaper in Mexico. A simple guide to judge whether a currency is overvalued is to consider it from the perspective of a tourist.
When the U. But, high-interest rates led to depressed demand and lower economic growth. The overvalued exchange rate also make UK exports uncompetitive, leading to a fall in manufacturing output. Firms responded to over-valued exchange rate by attempting to cut nominal wages.
This cut in wages led to the General Strike of Partly due to the overvalued exchange rate, the UK experienced high unemployment, low growth — even before the Great Depression. Real GDP was stagnant in the s. Assume that the country with an open economy has a fixed currency is currently overvalued in the foregion exchange mar true at the official exchange rate? This combination of higher prices and lower productivity makes their goods less attractive, leading to more imports and fewer exports; hence the very large current account deficits If they had their own exchange rate, we would see a devaluation in the currency making exports more competitive and imports cheaper.
Dealing with overvalued exchange rate in Euro The problem is that in the absence of a floating exchange rate it becomes more painful to solve the current account deficit. Related Effects of appreciation What causes an appreciation?
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