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Working Paper

Exchange Rate Overvaluation and Trade Protection : Lessons from Experience

AGRICULTURAL GROWTH AGRICULTURE BALANCE OF PAYMENTS BANKING CRISIS BLACK MARKET BLACK MARKET PREMIUM BUDGET DEFICITS CAPITAL CONTROLS CAPITAL FLIGHT CAPITAL OUTFLOWS CENTRAL BANK CLOSED ECONOMIES COMPETITIVE EXCHANGE COMPETITIVE EXCHANGE RATE COMPETITIVE EXCHANGE RATES CURRENCY BOARD CURRENT ACCOUNT CURRENT ACCOUNT DEFICIT DAMAGES DATA AVAILABILITY DEBT DEREGULATION DEVALUATION DEVELOPING COUNTRIES DEVELOPING COUNTRY DEVELOPMENT RESEARCH DOMESTIC PRICES DOMESTIC PRODUCTS ECONOMIC ACTIVITY ECONOMIC CONTRACTIONS ECONOMIC DEVELOPMENT ECONOMIC EFFICIENCY ECONOMIC GROWTH ECONOMIC PERFORMANCE ECONOMIC POLICIES ECONOMIC POLICY ECONOMIC PROBLEMS ECONOMIC SITUATION ECONOMIC STABILITY ECONOMICS EQUILIBRIUM EXCHANGE RATE EXCHANGE RATE MISALIGNMENT EXCHANGE RATE POLICIES EXCHANGE RATE POLICY EXCHANGE RATE REGIME EXCHANGE RATE REGIMES EXCHANGE RATES EXPORT EARNINGS EXPORT GROWTH EXPORTS EXTERNAL FACTORS EXTERNAL SHOCKS EXTERNAL TRADE FINANCIAL CRISES FINANCIAL CRISIS FINANCIAL SECTOR FINANCIAL SYSTEMS FISCAL DEFICIT FISCAL DEFICITS FISCAL POLICIES FIXED EXCHANGE RATE FIXED EXCHANGE RATE REGIMES FLEXIBLE EXCHANGE RATE SYSTEMS FLOATING EXCHANGE RATE FLOATING EXCHANGE RATE REGIME FOREIGN CURRENCY FOREIGN EXCHANGE FOREIGN INFLATION FOREIGN INTEREST RATES FOREIGN INVESTORS GDP GROWTH PROSPECTS GROWTH RATES HIGH INFLATION HIGH RATES IMPORT LIBERALIZATION IMPORT SUBSTITUTION IMPORTS INDEXATION INDUSTRIAL POLICY INDUSTRIALIZATION INTEREST RATES INTERNATIONAL COMPETITIVENESS INTERNATIONAL INVESTORS INTERNATIONAL MARKETS INTERNATIONAL MONETARY FUND INTERNATIONAL TRADE LONG RUN LONG TERM MACROECONOMIC STABILIZATION MARKET PRICES MONETARY EXPANSION MONEY SUPPLY NATIONAL INCOME NATIONAL INCOME ACCOUNTING NOMINAL ANCHOR NOMINAL EXCHANGE RATE OIL OIL PRICES OPEN ECONOMIES OVERVALUATION OVERVALUED EXCHANGE OVERVALUED EXCHANGE RATES POLICY INSTRUMENT POLICY INSTRUMENTS POLICY MAKERS POLICY RESEARCH POLICY TARGETS PRODUCERS PRODUCTIVITY PURCHASING POWER QUOTAS REAL APPRECIATION REAL EXCHANGE REAL EXCHANGE RATE REAL EXCHANGE RATES REAL GDP REAL OUTPUT REAL TERMS REAL WAGES RENT SEEKING RESOURCE ALLOCATION SAVINGS SLOW GROWTH STRUCTURAL ADJUSTMENT SUSTAINED GROWTH TARIFF BARRIERS TAX REFORM TERMS OF TRADE TIGHT MONETARY POLICY TRADABLE GOODS TRADE BALANCE TRADE BARRIERS TRADE DEFICIT TRADE LIBERALIZATION TRADE POLICIES TRADE POLICY TRADE REFORMS TRADE REGIME TRADE REGIMES TRADE SHOCKS TRANSITION COUNTRIES TRANSMISSION MECHANISM TROUGH UNEMPLOYMENT UNEMPLOYMENT RATE WAGE RIGIDITIES WORLD COMMUNITY
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World Bank, Washington, DC
Africa | East Asia and Pacific | Europe and Central Asia | Latin America & Caribbean | Sub-Saharan Africa | West Africa | Argentina | Chile | Ghana | Korea, Republic of | Malaysia | Turkey | Uruguay
2015-07-29T15:34:56Z | 2015-07-29T15:34:56Z | 2000-02

Despite a trend toward more flexible rates, more than half the world's countries maintain fixed or managed exchange rates. In the 1980s and 1990s, developing countries as a group progressively liberalized their trade regimes, but some governments defend their exchange rate in actions that run counter to long-run plans for liberalization. Without discussing the relative merits of fixed and flexible exchange rate systems, the authors note that exchange rate management in many countries has resulted in overvaluation of the real exchange rate. Roughly twenty five percent of the countries for which data are available have overvalued exchange rates, with black market premiums from 10 percent to more than 100 percent. After surveying the literature, the authors present lessons from experience about what has worked (or not) in response to crises involving external shocks and external trade deficits - and why. Trying to defend an overvalued exchange rate with protectionist trade policies is a classic pattern, but experience shows such protection does significantly retard the country's growth, and delay its integration into the world trading community. In fact, and overvalued exchange rate is often the root cause of protection, preventing the country from returning to more liberal trade policies that allow growth and integration into the world community without exchange rate adjustment. Most developing countries have downward price and wage rigidities and, with an external trade deficit, require some form of nominal exchange rate adjustment to restore external equilibrium. The authors present cross-country econometric and case study evidence - citing examples from Argentina, Chile, Ghana, the Republic of Korea, Malaysia, Turkey, Uruguay, and Sub-Saharan Africa (including the CFA zone) - that overvalued exchange rates reduce economic growth. Defending the exchange rate, they show, has nor no medium-term benefits, since falling reserves will eventually force devaluation. Better to have devaluation occur without further debilitating losses in reserves and lost productivity because of import controls. After devaluation the exchange rate will reach a new equilibrium, strongly influenced by government and central bank policies.

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