The Effect of Exchange Rate Disequilibrium and Financial Integration on Economic Growth

Abstract

We identify the determinants of the equilibrium real exchange rates (RER) in 10 selected countries of South and South East Asia and estimate the RER distortion by testing the effect of international financial integration (IFI) on economic growth. We use a simple model that determines the equilibrium RER and a dynamic model of endogenous growth that traces the effect of the RER distortion. We applied the techniques of non-stationary dynamic panel, the tests of panel cointegration, and the method of least squared dynamics (DOLS) to estimate the relationship of cointegration. We also use the technique of Generalized Moments Method (GMM) in the system as applied to panel data to estimate the equation of dynamic growth. The IFI constitutes an important factor of long-term RER. An increase of it led to a long-term RER depreciation in the region. The evolution of the RER distortion for 1979-2004 was persevering and recurring: it was an alternation between periods of RER overvaluation and undervaluation in the region. The RER fluctuation in the short-term played against economic growth.