The Impact of Foreign Currency Exposure on Economic Growth

Abstract

We aim to investigate the growth effects of financial vulnerabilities in advanced economies (AEs) and emerging and developing economies (EDEs) for the period of 1970-2018. We developed a new method to measure the foreign currency exposure by exploiting the novel data on currency composition of cross-border bank flows and international debt securities. We show that currency exposure does cause lower growth outcomes and depreciation amplifies the effect. Unlike previous work, our results show original sin and currency mismatches indeed matter for AEs as well. Our findings suggest that economies are better off with fixed exchange rates when they have greater external vulnerabilities. Thus, adopting fixed exchange rate regime can avoid the currency risk and volatile capital flows. Further, we find the linkage between long-run effects of currency exposure on economic growth. This study highlight the need for improvement in institutions to lower the currency exposure, such as better monetary and fiscal policy.