How do currency misalignments’ threshold affect economic growth?

► We examine the link between exchange rate misalignments and economic growth. ► Undervaluation plays a key role in the reversal of trend growth. ► Currency undervaluation acts positively on growth for developed and Asian countries. ► Undervalued currency is not such a relevant strategy for emerging countries. Based on panel smooth transition regressions, this paper determines for a large sample of developed and emerging countries, the value of currency misalignments from which we observe a regime shift in economic growth, over the 1980–2009 period. Misalignments, defined as the difference between the current real exchange rate and its equilibrium counterpart, are derived from the behavioural equilibrium exchange rate (BEER) approach. Our estimate relies on recent panel cointegration techniques that allow for heterogeneity and cross-sectional dependencies. We also control for the presence of structural breaks. Our findings show that our misalignments index plays a key role in the reversal of trend growth. Although the undervaluation of their currency acts positively on their growth, emerging countries cannot base their strategy on this finding to promote growth. We relate this result to the adverse effects of depreciation, as in “original sin”. The implications of our findings, in terms of economic policy, clearly emphasise the economic leverage role of undervaluation: it remains a powerful cyclical instrument but has to be, nevertheless, employed with precautionary to be globally and internationally consistent.