Real Exchange Rate Misalignment and Economic Growth: The Case of Trinidad and Tobago

Conventional economic theory outlines that developing countries experience economic growth through an undervalued exchange rate and that exchange rate overvaluations has negative long term effects on economic growth. This paper examined the impact of exchange rate movements as well as exchange rate misalignments on economic growth for the Trinidad and Tobago economy over the period 1960 to 2016. We find statistically significant evidence that both exchange rate appreciation and misalignments impact negatively on economic growth in the T&T economy. Drilling deeper we find interestingly that there exist no non-linear effects of exchange rate misalignments on growth. Specifically we find statistically significant evidence that both overvaluations and undervaluations hamper economic growth in the Trinidad and Tobago economy. We attribute this to T&T’s small and underdeveloped manufacturing sector that tends to be overlooked on account of its energy resources, in addition to the fact that its manufacturing sector is highly import oriented. A major policy recommendation would be for the critical reassessment of the rules governing the HSF, as government expenditure was allowed to follow energy revenues due to its current limitations.