Abstract

Departing from the literature that established a positive relation between exchange
rate undervaluation and economic growth, this paper explores the causes of persistent
undervaluation (or overvaluation) of the exchange rate. We first discuss the variables
that could explain persistent misalignment of the real exchange rate on a theoretical basis.
Then we present empirical evidence of the relation between those variables in selected country
groups. We proceed by employing econometric models to estimate the overvaluation or
undervaluation based on a panel dataset comprising 119 countries from 1980 to 2022. Our
findings indicate that countries with higher savings rates, government debt, and openness to trade tend to exhibit a more undervalued currency, the opposite happening to countries with
better terms of trade and larger capital inflows.

JEL Classification: F31; F41; F43.