The effect of currency devaluation on output: The case of ethiopian economy

Abstract

This paper assesses the short and long run effects of currency devaluation on output growth in Ethiopia. The study is conducted by using quarterly time series data over the period ranging from 1998.Q1 to 2010.Q4 and employing a vector auto regression (VAR) model. By controlling the monetary and fiscal policies, it is found that currency devaluations are contractionary in the long run and neutral in the short-run. Other results are that monetary policy has positive effect on output growth, while total government expenditure has negative effect. Moreover, this study clarifies that devaluation explains a considerable part of real gross domestic product change in Ethiopia. Since the Ethiopian export is dominated by primary agricultural products, it is insensitive for the change in exchange rate; it is not also possible for the government to allow market forces to determine the value of Ethiopian birr. Policy intervention is needed to balance the adverse impact of exchange rate movements until the economy is well transformed from agricultural sector to industrial sector and then, the economy becomes less dependent on imported raw materials. Thus, monetary policy plays a bigger role since it affects the total output positively and significantly.

Asymmetric impact of real effective exchange rate changes on domestic output revisited: evidence from Egypt

“…Our results are also in line with those of Shahbaz et al. (2012), who found that the effect of real devaluation on economic growth is contractionary in Pakistan and Ayen (2014), who found currency devaluations to be contractionary in the long run and neutral in the short run in Ethiopia.…”

“…These results are similar to the findings of several earlier studies, such as Nusair (2021) for Malaysia, in which appreciations have no long-run effect on output depreciations are contractionary. Our results are also in line with those of Shahbaz et al (2012), who found that the effect of real devaluation on economic growth is contractionary in Pakistan and Ayen (2014), who found currency devaluations to be contractionary in the long run and neutral in the short run in Ethiopia.…”

“…, 2014; Shahbaz et al. , 2012) and a third group of studies found a neutral effect for currency changes on domestic output (Ayen, 2014; Bahmani-Oskooee, 1998; Upadhyaya and Upadhyay, 1999). For example (Gylfason and Schmid, 1983) presented a basic macroeconomic model wherein devaluation affects real income and production via the supply side's cost of imported inputs and the demand side's exports, imports and expenditures.…”

“…The authors found that contractionary devaluation is not contingent upon the type of economy or the exchange rate regime; it may happen in developed and developing countries. Ayen (2014) found that currency devaluations are observed to be contractionary in the long run but neutral in the short run in Ethiopia.…”

“…Empirical time-series evidence on the impact of currency changes on domestic output is inconclusive. While some studies found an expansionary output effect for currency devaluation/depreciation (Bahmani-Oskooee and Rhee, 1997; Gylfason and Schmid, 1983;Ratha, 2010), other studies found devaluation/depreciation contractionary (An et al, 2014;Shahbaz et al, 2012) and a third group of studies found a neutral effect for currency changes on domestic output (Ayen, 2014;Bahmani-Oskooee, 1998;Upadhyaya and Upadhyay, 1999). For example (Gylfason and Schmid, 1983) presented a basic macroeconomic model wherein devaluation affects real income and production via the supply side's cost of imported inputs ITPD 7,1 and the demand side's exports, imports and expenditures.…”