ABSTRACT
In the previous chapters we saw that the market does not guarantee that the exchange rate floats around the competitive equilibrium – the industrial equilibrium – because in developing countries there is a tendency to the cyclical and chronic overvaluation of the exchange rate. There are structural and policy causes for such tendency, namely the Dutch disease (a secondary cause is the fact that the profit and the interest rates tend to be higher in developing countries), whereas the policy causes are the growth cum foreign savings policy including the practice of high interest rates to attract capitals, the use of the exchange rate to control inflation, and a fiscal policy involving budget deficits inconsistent with the current account surplus, which will materialize insofar as the Dutch disease is neutralized and the exchange rate begins to float around the industrial, not the current equilibrium. In the previous chapter we discussed the Dutch disease; in this chapter we discuss the policy causes of the overvaluation, which are associated, directly or indirectly, to excessive or unnecessary capital inflows.
