Exchange Rate and Economic Growth

The argument that a policy of currency depreciation would boost economic growth by increasing competitiveness is based on a short term partial equilibrium analysis and only considers one mechanism of transmission. A broader analysis of the economic dynamics suggest that, in the case of Costa Rica, such policy would have a marginal effect on the long term growth with a high cost in terms of inflation. This research evaluates the impact on economic growth of the change in Costa Rica´s exchange rate regime in October 2006 from a twenty year old crawling peg with the US dollar to a scheme of floating within bands. A structural macroeconomic model is estimated in order to measure the effect of nominal exchange rate movements and its volatility on economic growth from 1991 to 2014. The model is used to simulate the effects of keeping the crawling peg regime during the second part of the sample period. Results show that the average GDP growth rate between 2007 and 2014 under the crawling peg regime would have been comparable to that under the floating within bands regime, whereas the rate of inflation would have been substantially higher