The Real Exchange Rate and Economic Growth

It is a pleasure to be here in Trinidad and Tobago and an honor to deliver the W. Arthur Lewis Lecture. I only had the opportunity of meeting Professor Lewis once. The occasion was a talk I gave at Princeton when I was on the job market in 1980. That this was a one-time encounter will tell you that I didn’t get the job. In the event, Sir Arthur had just published his great book, Growth and Fluctuations, 1870-1913, which covers some of the same ground as this lecture, albeit with considerably greater authority. Traditionally, the real exchange rate has not exactly been at the center of analyses of economic growth. It featured not at all in the first generation of neoclassical growth models or in their practical policy incarnations, which focused on the determinants of savings and investment. That these were closed-economy models dictated that there was no role for the real exchange rate, defined as the ratio of the relative prices of nontraded goods (all goods being nontraded in closed economies). Applications of the early neoclassical model having focused attention on the large fraction of output growth not explained by the growth of observable factor inputs, subsequent treatments considered the “capability ” of societies to raise the productivity of those inputs, in turn directing attention to domestic institutions. Institutions being deeply embedded, it is not obvious that they are shaped by exchange rate policy, especially in the short run. The most recent generation of neoclassical growth models can be thought of as putting flesh on these analytical bones. They consider, inter alia, the system of property rights (e.g. patent and