Does the financial sector cause an appreciation of the real exchange rate

Abstract: Abstract In developed economies industry was once the backbone of the economy and was seen as the machinery behind economic growth. During the past decades, industry’s importance has been diminishing in advanced economies. The trend has been stronger in some countries than in others but seems rather consistent over time. Furthermore the financial sector has enjoyed vast growth since the 1980’s. In the countries where financial sector growth has been particularly strong it appears to have replaced industry as the largest sector. In this paper the real exchange rate is examined to investigate if growth in the financial sector has a tendency to crowd out industry through an appreciating exchange rate. The study is based on the framework first developed by Corden and Neary (1982) to investigate the Dutch disease. Here it is applied to a situation where the financial sector is booming instead of a natural resource sector which was the original set up of the model. United States, United Kingdom, Germany and Sweden are considered in the study. Of these countries the two former ones have large financial sectors and the later ones have rather strong industry sectors. An OLS regression is applied to investigate the relationship between the real exchange rate and relative productivity of the financial sector. However, the regression fails to prove any relationship, thereby no support for a crowding out effect could be found.