Interdependency of Real Exchange Rate, Trade, Innovation, Structural Change and Growth

This paper analyzes the impact of the real exchange rate on trade, structural change and growth. We point out a new approach to monetary growth policy in an open economy with trade and foreign direct investment. Moreover, the analysis presents a paradox effect with respect to the link between process innovations and the price level: The latter can rise if there are process innovations provided that the income elasticity of the demand for money is between zero and unity. We also look into the more traditional Balassa-Samuelson effects and consider the major impact of real exchange rate changes on structural change and on economic growth, the latter including a modified neoclassical model with endogenous growth. In addition, we consider aspects of optimum growth. Main policy conclusions are that one should avoid massive overshooting. Poor countries willing to catch up with partner countries in an integration area would be well advised to promote foreign direct investment inflows and to stimulate upgrading of human capital. Supporting R&D is also crucial for economic catching up.