Exchange Rate Volatility and Productivity Growth: The Role of Financial Development,’’ NBER Working Paper No. 12117

Angeles and Guillermo Vuletin provided able research assistance. We acknowledge \u85nancial support from the Fondation Banque de France. The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or IMF policy. 1 This paper o¤ers empirical evidence that real exchange rate volatility can have a signi\u85cant impact on the long-term rate of productivity growth, but the e¤ect depends critically on a countrys level of \u85nancial development. For countries with relatively low levels of \u85nan-cial development, exchange rate volatility generally reduces growth, whereas for \u85nancially advanced countries, there is no signi\u85cant e¤ect. Our empirical analysis is based on an 83 country data set spanning the years 1960-2000; our results appear robust to time window, alternative measures of \u85nancial development and exchange rate volatility, and outliers. We also o¤er a simple monetary growth model in which real exchange rate uncertainty exacerbates the negative investment e¤ects of domestic credit market constraints. Our approach delivers results that are in striking contrast to the vast existing empirical exchange rate literature, which largely \u85nds the e¤ects of exchange rate volatility on real activity to be relatively small and insigni\u85cant. 2