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Are Devaluations Contractionary?

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  • Sebastian Edwards

Abstract

Recently a number of authors have criticized the role of devaluations in traditional stabilization programs. It has been argued that, contrary to the traditional view, devaluations are contractionary, and generate a decline in aggregate output. In spite of the renewed theoretical interest in the possible contractionary effects of devaluations, the empirical evidence on the subject has been quite sketchy. In this paper the Khan and Knight (1981)model is extended to empirically address the issue of contractionary devaluations. The extended model considers the effect of money surprises, fiscal factors, terms of trade changes and devaluations on the level of real output. The results obtained, using a variance components procedure on data for 12 developing countries, provide some support to the short-run contractionary devaluation hypothesis; the results obtained indicate that in the short-run a devaluation will generate a decline in aggregate output. It is also found that after one year a devaluation will have an expansionary effecton output. The evidence suggests that in the long run, devaluations will have no effect on output.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1676.

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Date of creation: Aug 1985
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Publication status: published as Edwards, Sebastian. "Are Devaluations Contractionary?" Review of Economics and Statistics, Vol. 68, No. 3, (August 1986), pp. 501-508.
Handle: RePEc:nbr:nberwo:1676

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  1. Gylfason, Thorvaldur & Risager, Ole, 1984. "Does devaluation improve the current account?," European Economic Review, Elsevier, Elsevier, vol. 25(1), pages 37-64, June.
  2. P. Krugman & L. Taylor, 1976. "Contractionary Effects of Devaluations," Working papers 191, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Thorvaldur Gylfason & Michael Schmid, 1983. "Does Devaluation Cause Stagflation?," Canadian Journal of Economics, Canadian Economics Association, Canadian Economics Association, vol. 16(4), pages 641-54, November.
  4. McCallum, Bennett T, 1979. "On the Observational Inequivalence of Classical and Keynesian Models," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(2), pages 395-402, April.
  5. 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.
  6. Katseli, Louka T, 1983. "Devaluation: A Critical Appraisal of the IMF's Policy Prescriptions," American Economic Review, American Economic Association, American Economic Association, vol. 73(2), pages 359-63, May.
  7. Clements, Kenneth W. & Jonson, Peter D., 1979. "Unanticipated money, 'disequilibrium' modelling and rational expectations," Economics Letters, Elsevier, Elsevier, vol. 2(4), pages 303-308.
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