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Supply-side effects of exchange rates, exchange rate expectations and induced currency depreciation

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  • Ali, Syed Zahid
  • Anwar, Sajid

Abstract

Within the context of a small open economy model, this paper examines the repercussions of induced currency depreciation. The results presented in this paper are based on a model with firm microeconomic foundations and which takes into account both the supply and demand-side effects of exchange rate variations. The distinguishing feature of the model is the role of exchange rate expectations. We consider three kinds of expectations; adaptive, extrapolative, and regressive expectations. We also perform several sensitivity tests based on these expectations. Our simulation exercise shows that the effect of induced currency depreciation depends largely on supply-side effects. In most cases, we find that currency depreciation results in (i) a fall in output, (ii) an increase in prices and (iii) an improvement in the balance of trade. In the absence of weak supply-side effects of exchange rates, we find that, if the Marshall-Lerner conditions hold, then depreciation of the home currency has a favorable effect on output but its effect on the balance of trade is negative.

Suggested Citation

  • Ali, Syed Zahid & Anwar, Sajid, 2011. "Supply-side effects of exchange rates, exchange rate expectations and induced currency depreciation," Economic Modelling, Elsevier, vol. 28(4), pages 1650-1672, July.
  • Handle: RePEc:eee:ecmode:v:28:y:2011:i:4:p:1650-1672
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    Cited by:

    1. Ali, Syed Zahid & Anwar, Sajid & Valadkhani, Abbas, 2012. "Macroeconomic consequences of increased productivity in less developed economies," Economic Modelling, Elsevier, vol. 29(3), pages 621-631.
    2. Mihaela IAVORSCHI, 2015. "The Impact Of The Exchange Rate On The Commercials Flows," SEA - Practical Application of Science, Fundația Română pentru Inteligența Afacerii, Editorial Department, issue 7, pages 301-308, April.

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