Real exchange rate misalignments and economic growth in Sub-Saharan African countries

Abstract

This study examined the effect of real exchange rate misalignments on economic growth in sub-Saharan Africa (SSA) by employing 15 countries. The sample is subdivided into 7 lowincome countries and 8 middle-income countries. The dataset spans 41 years covering the period 1970-2010. The study examined this broad issue in piecewise fashion. In the first part, the study examined the validity of the Balassa-Samuelson Hypothesis (BSH) using a simplified regression model and within-effects estimations. The study found a negative and highly significant coefficient of the relative productivity term for the two subsamples (i.e. low-income SSA countries and middle-income SSA countries), in addition to the full sample. Thus, the study found a well-established BSH for the SSA countries considered. Second, the study examined the impact of the real exchange rate undervaluation on economic growth using a standard regression model with key control variables. The study constructed an index of undervaluation, following Rodrik (2008). The study also constructed a Hodrick- Prescott based undervaluation index in order to evaluate the robustness of the main undervaluation index. Generally, the study found undervaluation to promote growth and overvaluation to reduce it. The study found the effect of undervaluation on economic growth to weaken as countries migrate from the low-income bracket to the middle-income bracket. Moreover, the study examined whether the choice of the undervaluation measure mattered. The study found the choice of the undervaluation measure to matter. The Rodrik-type index appeared to overestimate the size of the impact of undervaluation on economic growth. Finally, the study examined whether the impact of undervaluation on growth was linear. The evidence showed that the impact of undervaluation on growth was linear, at least, for this study. The linear impact of real exchange rate movements on economic growth implied that undervaluation enhanced economic growth just as overvaluation hindered it.