Is the balance of payments constrained growth rate time-varying? Exchange rate over valuation, policy-induced recessions, deindustrialization, and long run growth

Abstract

A long-held view among macroeconomists in the UK and USA is that sustained currency over valuation, often the result of financial-sector dominance, weakens domestic macroeconomic performance, and results in premature deindustrialization. Similar concerns have been expressed about persistent, policy-induced recessions. According to balance of payments constrained growth (BPCG) theory, meanwhile, the BPCG rate in a multi-sector economy varies directly with the share of manufacturing in total output. This chapter develops a simple model that combines these observations to show how a temporary but persistent shock to the nominal exchange rate and/or domestic demand can both affect the actual rate of growth in the short run (by moving it away from the long-run equilibrium BPCG rate) and alter the BPCG rate itself (by lowering the income elasticity of demand for exports as a result of induced premature deindustrialization). The result is a time-varying balance of payments constrained growth (TV-BPCG) rate. Because actual growth and the TV-BPCG rate vary directly, the latter is also characterized as quasi path dependent.