REAL EXCHANGE-RATE MISALIGNMENT AND REDISTRIBUTION

Developing countries frequently maintain an overvalued nominal exchang e rate, resulting in real exchange rate misalignment. To finance impor t demand at the overvalued exchange rate, countries have to raise the level of income taxation or they have to resort to monetary finance. T his paper explains nominal and implicitly real exchange rate misalignm ent as the outcome of the political process. More specifically, the pa per explains the misalignment of an import exchange rate relative to a market exchange rate used for exports. Voters differ in their ownersh ip of a single factor of production. Real exchange rate overvaluation results if the median voter spends a relatively large share of his inc ome on the importable good. The political economy of explicit and impl icit import subsidies is first analyzed in a real model, which is then extended to include money holdings and exchange rate policy.