The Effect Of Real Exchange Rate Devaluation Or Depreciation On Output In Sub – Saharan Africa

ABSTRACT

The importance of economic growth and development for social welfare improvement cannot be overemphasized. For this reason, every country across the globe, especially, the developing and less developed ones, are making every effort necessary to develop and provide their citizens with an improved standard of living. These efforts include opening up their economies more to the rest of the world through international trade, capital flows and cooperation. Therefore, exchange rate policy issues become very important in the management of the economies of these countries, especially the issue of exchange rate devaluation or depreciation and its effect on output. In many Sub – Saharan African countries devaluation has been one of the most often used policies, be it IMF-sponsored or government initiated reform programmes. The aim of this study is to examine empirically whether real depreciation is expansionary or contractionary in sub – Sahara Africa using data from 35 subSahara African countries from 1984 to 2013. We also seek to examine the differential effects of the relative price ratio and the nominal exchange rate changes on real output. Following some previous studies that emphasize major political events such as elections and change in governments as affecting the path of the real exchange rate as well as business cycles affecting productivity and growth and variables relating to long-term growth, we follow Edison et al. (2002) by generating 3-years non-overlapping averages for the variables to even out the political economy effect of exchange rate changes and also to eliminate business-cycle fluctuations. Using the Generalized Methods of Moments (GMM) estimation technique, we find that the real exchange rate has contractionary effect on real output in the short run but its effect is neutral in the medium and the long runs. We also find that the contractionary impact of the real exchange rate emanates from the nominal exchange rate and not the relative price ratio.