Reconciling contrasting views on the growth effect of currency misalignments

This paper provides an in-depth analysis of the link between exchange rate misalignments and economic growth for a large sample of 170 countries over the 1973-2019 period. Although any significant departures from the equilibrium exchange rate levels are found undesirable, we show that undervaluations are more likely to stimulate economic growth in developing countries. However, this positive impact is observed only up to certain thresholds of development level and currency undervaluation. Consequently, strategies in developing countries that systematically undervalue currencies in real terms to foster growth should be carefully tailored, as they raise the risk for these economies of switching from a positive to a less favorable growth regime, depending on both their specific wealth level and the extent of their currency undervaluation. •We analyze the link between currency misalignments and economic growth.•Large undervaluations hurt growth in middle-income countries and lead to an economic slowdown in low-income economies.•Large overvaluations are less harmful to higher-income countries' growth compared to their lower-income counterparts.•Moderate currency misalignments are more likely to affect economic growth positively.