Civil Conflicts and Exchange Rate Misalignment: Evidence from MENA and Arab League Members

Abstract

Abstract For more than a decade, civil conflicts intensity has been high in the Middle East and North Africa, yet the monetary and financial impacts of such episodes have received relatively little attention. Using macroeconomic and conflict panel data for Arab League members, Iran and Turkey during the period 1970–2018, this paper constructs a country-specific real exchange rate misalignment index and adopts an instrumental variable approach to show that civil conflicts lead to real exchange rate overvaluations in the region: a 1 unit increase in civil conflict intensity leads to a 0.24 unit increase in the RER misalignment index. The results suggest that upward pressures on the real exchange rate, such as inflation resulting from physical capital and output loss, dominate. Economic policy during post-conflict transitions should mitigate this effect by incorporating a strategy to realign the currency.