The Role of Returns to Scale in the Relationship between Exchange Rate and Economic Growth

Abstract

This paper aims to understand how the returns to scale can boost or deprive the effects of exchange rate depreciation on economic growth. A simple mathematical model was developed to describe the problem of the exporting firm in this context of internationalization. Theoretical results show that exchange rate depreciations can boost the growth of production of firms with technologies with decreasing returns to scale, while in firms that have increasing returns of scale, the effect is null or negative. In addition, two important exchange rates were found for the firm's decision, namely the minimum operating exchange rate (MOE) and the reversal exchange rate (RVER). Therefore, the present model helps understanding the role that the returns to scale plays in the relationship between exchange rate and economic growth. Finally, the current study presents a few limitations that can be addressed in future research. For instance, the following statements can integrate them: 1) allow that firms to influence the exchange rate and place it above the minimum operational level; 2) considering new players in the markets considered and 3) take into account more input and outputs variables.