Are devaluations contractionary in MENA countries?

Abstract

Currency depreciation reduces aggregate supply by raising cost of imported inputs and increases aggregate demand by increasing its net export component. Depending on the relative strength of the two effects, depreciation could be expansionary or contractionary. We employ the bounds testing approach to cointegration and error-correction modelling to evaluate the effects of exchange rate depreciation on output growth, both in the short and in the long-run, across a sample of MENA countries. Exchange rate fluctuations are found to be important to fluctuations in real output growth in the short-run. Anticipated exchange rate depreciation may induce long-run expansionary or contractionary effects on output supply. Consistent with theory's predictions, the expansionary effect of unanticipated depreciation is only transitory on output growth. Nonetheless, unanticipated depreciation is found to have a contractionary effect on output growth in the long-run via an increase in the cost of imported inputs.