Growth and Poverty Reduction Under Globalization: The Systematic Impact of Exchange Rate Misalignment

This paper asseses of the role of economic growth in achieving the first target of the Millennium Development Goals (MDGs). The analysis is composed of two parts. First, we address economic growth as the most effective instrument for achieving poverty reduction. In evaluating feasibility we extend the “exit-time” concept and we find that at least one half of all the targeted countries will not achieve the first target of the MDGs if they continue on their historical trajectory. Second, we focus on accelerating the rate of growth in the poorest countries of the world if the MDGs are to be achieved. In a standard reduced-form growth-regression model we introduce the exchange rate misalignment defined as the chronic deviation between the nominal exchange rate and the purchasing power parity rate. We confirm the negative relationship between misalignment and growth. Most importantly, the analysis proves misalignment originates in the currency substitution that takes place in developing countries that results in the systematic devaluation of their currencies. This finding highlights the importance of the proper combination of trade and exchange rate policies in fostering growth in developing countries.