Sustained exchange rate misalignment and economic development

Employing propensity score reweighting and event-based strategies, we provide evidence that sustained real exchange rate (RER) misalignments have significant effects on economic development: positive on GDP per capita and capital stock in the case of undervaluation, and negative on the capital stock in the case of overvaluation. Moreover, a large set of structural parameters are tested, and the results point to some structural changes during and after these episodes: real undervaluations increase investment and the share of intermediate and capital goods imported, and decrease the shares of consumption, wages, the services sector, and consumption goods imported. Overvaluations cause a reduction in investment, and an increase in the share of the services sector, and of commodities and natural-resources in exports. We also find evidence that these effects are heterogeneous by income level. Our approaches to analyzing sustained misalignments help us address endogeneity and heterogeneity concerns, mismeasurement issues, identify causal channels, and incorporate issues relating to expectations and other mechanisms that play an important role in structural transformation.