The Real Exchange Rate, Mercantilism and the Learning by Doing Externality
NBER Working Paper No. 13853
This paper examines the degree to which the learning by doing externality [LBD] calls for an undervalued exchange rate, a policy suggested by recent empirical studies which concluded that mildly undervalued real exchange rate may enhance growth. We obtain mixed results. For an economy where LBD externality operates in the traded sector, real exchange rate undervaluation may be used in order to internalize this externality, if the LBD calls for subsidizing employment in the traded sector. Yet, we also find that these results are not robust to changes in the nature of the LBD externality. If the LBD externality is embodied in aggregate investment, the optimal policy calls for subsidizing the cost of capital in the traded sector, and there is no room for undervalued exchange rate policy. In addition, a deliberate undervaluation by means of hoarding reserves may backfire if the needed sterilization would increase the cost of investment in the traded sector.
Published: REAL EXCHANGE RATE, MERCANTILISM AND THE LEARNING BY DOING EXTERNALITY Joshua Aizenman1, Jaewoo Lee2,* Article first published online: 16 JUL 2010 DOI: 10.1111/j.1468-0106.2010.00505.x © 2010 The Authors. Journal compilation © 2010 Blackwell Publishing Asia Pty Ltd Issue Pacific Economic Review Pacific Economic Review Volume 15, Issue 3, pages 324–335, August 2010
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