Output and the real exchange rate in developing countries : An application to Mexico

In Mexico over the past few decades, devaluations have been associated nearly exclusively with economic contraction, while real appreciations have been followed by expansions. The authors attempt to disentangle the possible factors underlying the correlation - reverse causation from output to the real exchange rate, spurious correlation with third factors such as capital account shock and temporary contradictory effects of devaluation - and determine whether a positive long-run effect of real depreciation on output is in the data. (DSE/DÜI)