Output and the Real Exchange Rate in Developing Countries: An Application to Mexico

66 Pages Posted: 27 Jun 1997

See all articles by Steven B. Kamin

Steven B. Kamin

Board of Governors of the Federal Reserve System

John H. Rogers

Board of Governors of the Federal Reserve System - Trade and Financial Studies Section

Date Written: May 1997

Abstract

Since Mexico's devaluation of the peso in 1994, some observers have called for policies designed to keep the real exchange rate highly competitive in order to promote exports and output growth. However, over the past few decades, devaluations of the real exchange rate have been associated nearly exclusively with economic contraction, while real appreciations have been followed almost invariably by expansions in economic activity. The purpose of this paper is to attempt to disentangle the possible factors underlying this correlation--(1) reverse causation from output to the real exchange rate, (2) spurious correlation with third factors such as capital account shocks, and (3) temporary contractionary effects of devaluation--and determine whether, once those factors are accounted for, a positive, long-run effect of real depreciation on output can be identified in the data. Based on the results of a VAR model designed to explore the linkages between the real exchange rate and output, we conclude that even after sources of spurious correlation and reverse causation are controlled for, real devaluation has led to high inflation and economic contraction in Mexico. While changes in Mexico's economic structure and financial situation may qualify the future applicability of this conclusion, we view our findings as pointing to substantial risks to targeting the exchange rate at too competitive a level.

JEL Classification: F3, F4

Suggested Citation

Kamin, Steven B. and Rogers, John H., Output and the Real Exchange Rate in Developing Countries: An Application to Mexico (May 1997). FRB International Finance Discussion Paper No. 580. Available at SSRN: https://ssrn.com/abstract=774 or http://dx.doi.org/10.2139/ssrn.774

Steven B. Kamin (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-3339 (Phone)
202-736-5638 (Fax)

John H. Rogers

Board of Governors of the Federal Reserve System - Trade and Financial Studies Section ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2873 (Phone)
202-736-5638 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
981
Abstract Views
3,808
rank
22,801
PlumX Metrics