THE REAL EXCHANGE RATE AND SUBSTITUTION BETWEEN DOMESTIC AND FOREIGN SAVINGS

THEORY AND EMPIRICAL ANALYSIS

Abstract

The main objective of this work is to empirically evaluate the existence of substitution or complementarity of internal savings by external savings in a heterogeneous sample of developing economies, as well as the role of real exchange rate (RER) misalignment on the domestic savings of these economies.  In order to meet this goal, four different methods of econometric estimations are used for panel data in a sample of 40 countries between 1990 and 2011. Using the real exchange rate undervaluation index adjusted for the Balassa-Samuelson effect proposed by Rodrik (2008), the results show the occurrence of a statistically significant process of substitution of internal savings for external savings; as well as a positive and equally significant effect of the level of the real exchange rate (RER) on domestic savings. This means that a competitive level for the real exchange rate induces an increase in the surplus (or deficit reduction) in current account. Thus, producing an increase in the domestic savings through, mainly, increased profits and corporate savings.