Exchange Rate Policy and Development
Working Paper #34
This paper describes the Nominal Anchor Approach, the Real Targets Approach, and the Exchange Stability Approach to the formulation of exchange-rate policy, as presented by Max Corden. It argues that these approaches need to be supplemented by a fourth approach, which it terms the Development Strategy Approach, to represent the thought especially of Bela Balassa. The Development Strategy Approach regards choice of the exchange rate as a key strategic element in whether an economy will grow or stagnate. A growth strategy requires an exchange rate sufficiently competitive to motivate entrepreneurs to invest with the objective of going out and selling non-traditional exports on the world market.
But it is silly to conclude from this, as some supporters of China's policies have done, that a more competitive exchange rate is always better for growth, and that currency revaluation is necessarily bad for growth. While the incentive to invest will necessarily be greater with a more competitive exchange rate, the ability to invest may be curtailed by a shortage of investible resources as real resources are diverted into a current account surplus and low-yielding reserve accumulation. Growth is maximized where the increased incentive to invest (demand side) is just balanced by the decreased ability to invest (supply side). The paper constructs a formal model to illustrate this trade-off. It also discusses the range of instruments that may help a government to limit the capital inflows that might otherwise threaten to produce an overvalued currency in good times, and it discusses the problem of inconsistent payments objectives that could arise in a world such as that portrayed.
About the Author
Peter G. Peterson Institute for International Economics
John Williamson is a Visiting Fellow at the Center for Global Development and also a Senior Fellow at the Peter G. Peterson Institute for International Economics. He was Project Director for the UN High-Level Panel on Financing for Development (the Zedillo Report) in 2001; on leave as Chief Economist for South Asia at the World Bank during 1996–99; economics professor at Pontifica Universidade Católica do Rio de Janeiro (1978–81), University of Warwick (1970–77), Massachusetts Institute of Technology (1967, 1980), University of York (1963–68), and Princeton University (1962–63); adviser to the International Monetary Fund (1972–74); and economic consultant to the UK Treasury (1968–70). He is author, coauthor, editor, or coeditor of numerous studies on international monetary and development issues.