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Effects of the Exchange Rate on Output and Price Level: Evidence from the Pakistani Economy

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  • Munir A. S. Choudhary

    ()
    (Department of Economics, University of the Punjab, Pakistan.)

  • Muhammad Aslam Chaudhry

    ()
    (Department of Economics, University of the Punjab, Pakistan.)

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    Abstract

    The question of whether devaluation of the currency affects output positively or negatively has received considerable attention both from academic and empirical researchers. A number of empirical studies have supported the contractionary devaluation hypothesis using pooled time series data from a large number of heterogeneous countries. Since the effects of devaluation on output and the price level may not be uniform across all developing countries, the empirical results can not be generalized for all countries. In addition, almost none of the empirical studies used to test the contractionary devaluation hypothesis separate the effects of devaluation from import prices. Thus, a country specific study is needed that separate the effects of devaluation from the import price effects. This paper uses a VEC model to analyze the effects of the exchange rate on output and the price level in Pakistan for the period 1975-2005. Our analysis shows that devaluation has a positive effect on output but a negative effect on the price level. Thus, the evidence presented in this paper does not support the contractionary devaluation hypothesis for the Pakistani economy.

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    Bibliographic Info

    Article provided by Department of Economics, The Lahore School of Economics in its journal Lahore Journal of Economics.

    Volume (Year): 12 (2007)
    Issue (Month): 1 (Jan-Jun)
    Pages: 49-77

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    Handle: RePEc:lje:journl:v:12:y:2007:i:1:p:49-77

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Sweder van Wijnbergen, 1986. "Exchange Rate Management and Stabilization Policies in Developing Countries," NBER Chapters, in: Economic Adjustment and Exchange Rates in Developing Countries, pages 17-42 National Bureau of Economic Research, Inc.
    2. Pesaran, M. H. & Shin, Y., 1997. "Generalised Impulse Response Analysis in Linear Multivariate Models," Cambridge Working Papers in Economics 9710, Faculty of Economics, University of Cambridge.
    3. Thorvaldur Gylfason & Michael Schmid, 1983. "Does Devaluation Cause Stagflation?," Canadian Journal of Economics, Canadian Economics Association, vol. 16(4), pages 641-54, November.
    4. Knight, J B, 1976. "Devaluation and Income Distribution in Less-Developed Economies," Oxford Economic Papers, Oxford University Press, vol. 28(2), pages 208-27, July.
    5. Upadhyaya, Kamal P., 1999. "Currency devaluation, aggregate output, and the long run: an empirical study," Economics Letters, Elsevier, vol. 64(2), pages 197-202, August.
    6. P. Krugman & L. Taylor, 1976. "Contractionary Effects of Devaluations," Working papers 191, Massachusetts Institute of Technology (MIT), Department of Economics.
    7. Gylfason, Thorvaldur & Radetzki, Marian, 1991. "Does Devaluation Make Sense in the Least Developed Countries?," Economic Development and Cultural Change, University of Chicago Press, vol. 40(1), pages 1-25, October.
    8. M. Aynul Hasan & Ashfaque H. Khan, 1994. "Impact of Devaluation on Pakistan's External Trade: An Econometric Approach," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 33(4), pages 1205-1215.
    9. Edward, Sebastian, 1986. "Are Devaluations Contractionary?," The Review of Economics and Statistics, MIT Press, vol. 68(3), pages 501-08, August.
    10. Solimano, Andres, 1986. "Contractionary devaluation in the southern cone : The case of Chile," Journal of Development Economics, Elsevier, vol. 23(1), pages 135-151, September.
    11. Gylfason, Thorvaldur & Risager, Ole, 1984. "Does devaluation improve the current account?," European Economic Review, Elsevier, vol. 25(1), pages 37-64, June.
    12. Mohsen Bahmani-Oskooee & Hyun-Jae Rhee, 1997. "Response of Domestic Production to Depreciation in Korea: an Application of Johansen's Conintegration Methodology," International Economic Journal, Taylor & Francis Journals, vol. 11(4), pages 103-112.
    13. Mohsen Bahmani-Oskooee & Souphala Chomsisengphet & Magda Kandil, 2002. "Are devaluations contractionary in Asia?," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 25(1), pages 69-82, January.
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    Cited by:
    1. Muhammad, Shahbaz & Faridul, Islam & Naveed, Aamir, 2011. "Is devaluation contractionary? empirical evidence for Pakistan," MPRA Paper 32520, University Library of Munich, Germany, revised 01 Aug 2011.

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