Exchange Rate Misalignment and Economic Growth in Pakistan: The Role of Financial Development

Zainab Jehan, Iffat Irshad


This study endeavours to examine empirically how real exchange
rate (RER) misalignment affects economic growth in Pakistan. In this
regard, we have not only estimated the direct impact but also the
indirect impact of misalignment on economic growth by using the
financial development channel. We have used time series data ranging
from 1980 to 2016 to carry out the empirical analysis. After testing the
time series properties of the selected variables, we computed long run
equilibrium RER later used to calculate RER misalignment. Finally, we
estimated the impact of misalignment on per capita economic growth, both
direct and indirect. Our results reveal an adverse impact of RER
misalignment on economic growth. However, we report that financial
development helps in minimising the adverse impact of RER misalignment,
though not fully eliminating it. Based on the empirical findings, the
study suggests that exchange rate policies need to be managed more
cautiously. Moreover, the financial sector development needs to be
strengthened which may help in fully alleviating the adverse impact of
RER misalignment on economic growth. JEL Classification: F31, GOO, O47
Keywords: Real Exchange Rate Misalignment, Financial Development,
Economic Growth, FMOLS

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