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Economic Change and Restructuring

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01-11-2012

Is devaluation contractionary? Empirical evidence for Pakistan

Authors: Muhammad Shahbaz, Faridul Islam, Naveed Aamir

Published in: Economic Change and Restructuring | Issue 4/2012

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Abstract

The paper examines the effect of real devaluation on economic growth. In the empirical model we include few other theoretically justified variables e.g., money supply, foreign remittances, and government spending as they appear relevant for Pakistan. The ADF unit root test is used for stationarity of the series. Also, to capture possible structural breaks due to currency regimes shifts, the Saikkonen and Lütkepohl unit root test is used. We apply the ARDL bounds testing approach to cointegration to explore a long run relation among the series; and the variance decomposition method and impulse response function for the direction of causality. The findings affirm cointegrating relation among the series. Real devaluation exerts contractionary effect on economic growth. The results should help in formulating a comprehensive trade policy including the use of competitive devaluation as a tool to correct balance of payments problems.

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Dimitris (2004) and Asif et al. (2011) use bivariate framework, thus suffers from omitted variables bias. Asif used Engle-Granger cointegration procedure. Neither explored the potential for structural breaks.

Investigated the impact of currency devaluation on output growth in China using ARDL approach.

Examined the effect of devaluation on economic growth in the OECD countries. They found devaluation influences economic growth in 9 out of 23 economies; in six countries (Austria, Hungary, Poland, Portugal, Switzerland and Turkey), the impact of devaluation is contractionary; and in 3 of 9 countries (Finland, Germany and Sweden) devaluation raises output.

Used data from East Asia and Latin America they found that devaluation affects economic growth negatively in the post liberalization era.

Bahmani-Oskooee and Kandil (2007) examined the relationship between exchange rate changes and output growth for the period of 1953–2003 for Iran.

ARDL is not having the information about the structural break in time series data.

Results from the ADF tests are available from the authors upon request.

The ADF, and DF-GLS may be unreliable in the presence of structural breaks.

The descriptive statistics and pair-wise correlations for the variables are presented in Appendix for information of the interested reader.

The details of the method are not reported here but can be found from Lenne et al. (2003).

Depreciation increases exports by making exports relatively cheaper and discourages the imports by making imports relatively more expensive, thus improving trade balance.

See for details (Shahbaz et al. 2011).

Graphs of CUSUM and CUSUMsq are available from authors upon request.

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Title: Is devaluation contractionary? Empirical evidence for Pakistan
Authors: Muhammad Shahbaz
Faridul Islam
Naveed Aamir
Publication date: 01-11-2012
Publisher: Springer US
Published in: Economic Change and Restructuring / Issue 4/2012
Print ISSN: 1573-9414
Electronic ISSN: 1574-0277
DOI: https://doi.org/10.1007/s10644-011-9119-7

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