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Voluminous theoretical and empirical research shows that real exchange rate (RER) undervaluation could be conducive to economic development. Why do countries then often avoid the pursuit of policies that facilitate undervaluation or even intentionally pursue RER overvaluation? We address this question by investigating the economic/structural, institutional/political, and policy factors that explain the within-country variation in RER undervaluation in a baseline panel of 68 developing and 39 developed countries between 1988 and 2012 using OLS and GMM estimators. Our results indicate that the sectoral structure of the economy, functional distribution of income, the dependence of exports on imported inputs, the degree of central bank independence, balance sheet vulnerabilities, and technological sophistication are important determinants of RER levels. Our key results are robust to using alternative measures, estimation techniques, different samples, and additional control variables.



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