Devalu ation in Developing Countries: Expansionary or Contractionary?, Journalof Economic and Social Research 2(1) 2000: 59 - 83

ABSTRACT

This paper discusses the effects of devaluation on output growth in Less Developed Countries (LDCs).  The issue has played an important role in the economic and political agendas of developing countries for several decades during which devaluation has been one of the most frequently used policy tools under both IMF-regulated and independent stabilization programs in these countries.  Whether devaluation of the currency affects national income positively or negatively has also received considerable attention among academic researchers.

            In this paper, in order to analyze empirically whether or not devaluation results in output contraction in LDCs, data from 18 sample countries are used in a fixed-effect procedure.  LDCs are divided into two categories and two different regression analyses are conducted.  First, data from a group of 10 countries, including both manufacturing product exporters as well as agricultural and primary product exporters, are used to estimate a model of real output behavior for a period of 25 years.  Then, to investigate if there exists a qualitative difference between different countries in terms of the effect of devaluation on economic growth, data from two different groups of countries (8 manufacturing exporters, 8 agricultural and primary exporters) are analyzed for a 20-year period.  In addition to the change in real exchange rates, the role of monetary and fiscal policies, as well as terms of trade changes, are incorporated into the model as the possible determinants of real output growth.

The results indicate that devaluation creates a contractionary effect on output in the first year, whereas it has an expansionary effect in the following year.  Also, the results suggest that there is no qualitative difference between manufacturing exporters and agricultural exporters in terms of the effect of devaluation on output growth.  Fiscal expansion (increasing relative size of government expenditure) has a significant positive effect on output growth for all countries, regardless of their export composition.  The effect of terms of trade changes on output is generally negative for agricultural and primary exporters, but fluctuating for manufacturing exporters.  Manufacturing product exporters have a higher output growth trend than agricultural and primary exporters.

 

Keywords:  Devaluation; Developing Countries.