When Currencies Drift: Real Exchange Rate Misalignments and Economic Growth

Abstract Persistent deviations of exchange rates from their equilibrium values have long been viewed as a source of macroeconomic instability, yet there remains little consensus on when and under what conditions exchange rate misalignments affect long-term economic growth. This paper examines the growth effects of real exchange rate misalignments using a large cross-country panel spanning the period 1980–2023. Exchange rate misalignments are estimated within a Behavioral Equilibrium Exchange Rate (BEER) framework, and their dynamic effects on economic growth are analyzed using local projection methods. The results show that exchange rate misalignments, particularly episodes of currency overvaluation, are associated with significant, persistent, and cumulative declines of approximately 3.8 percentage points in real GDP per capita over a 5-year horizon. These adverse effects are concentrated in emerging market and developing economies, whereas advanced economies display greater resilience. Moreover, the growth costs of exchange rate misalignments are amplified under fixed and heavily managed exchange rate regimes and depend critically on initial macroeconomic conditions, particularly current account balances and fiscal positions. Overall, the findings demonstrate that the growth effects of exchange rate misalignments are highly heterogeneous, varying systematically across levels of economic development, exchange rate arrangements, and macroeconomic fundamentals.