A Group-Specific Heterogeneous Panel Approach to the Impact of Exchange-rate Regime on Economic Growth

This paper proposes a group-specific heterogeneous approach known as grouped fixed-effects to examine the impact of exchange-rate regime on economic growth. The research uses a panel consisting of 151 countries from 1999-2013. Grouped heterogeneity offers a parsimonious approach to capturing unobserved heterogeneity. Countries of similar economic institutions, economic activity, population density, and so forth, tend to adjust their long-run paths for the level of income per capita at the same speed - implying errors tend to be spatially correlated. The methodology is able to capture speed of adjustment effects to new long-run equilibriums in a parsimonious manner, which is essential to understanding factors involved in macroeconomic performance. Taking grouped patterns of heterogeneity into account, flexible and intermediate exchange-rate regimes are growth promoting relative to fixed-exchange rate regimes. These results are robust to a variety of sensitivity tests.