Some Multi-Country Evidence on the Effects of Real Exchange Rates on Output
23 Pages Posted: 13 Dec 2005
Date Written: May 1998
The simultaneous occurrence of devaluation and recession in Mexico in 1995, as well as in the East Asian economies more recently, appears to contradict the conventional view that devaluations are expansionary. Moreover, a sizeable theoretical and empirical literature also argues that, contrary to the predictions of textbook analysis, exchange rate devaluations may be contractionary rather than expansionary. However, prior statistical analyses of the effects of exchange rate devaluation on output have been subject to several limitations: (i) they have failed to distinguish adequately between short and long-run effects; (ii) they have not controlled for the full range of external shocks; and (iii) they have not considered whether the effects of devaluation might differ between different regions of the world. The purpose of this paper is to estimate the impact of devaluation on output for 27 countries while attempting to address these limitations in previous empirical analyses. We find no evidence that devaluations are contractionary in the long run. Additionally, controlling for sources of spurious correlation and reverse causality appears to mute the measured contractionary effect of devaluation in the short run, although this effect remains even after these controls are introduced. Finally, while the literature on contractionary devaluation has focused primarily on developing countries, we found no evidence that this effect is stronger in developing countries than in industrialised countries.
JEL Classification: F31, F41
Suggested Citation: Suggested Citation