Abstract
In this paper we have empirically investigated the validity of the contractionary devaluation hypothesis in Turkey by using tlie Structural VAR methodology developed by Bernanke (1986). The model used in this study shows that contrary to conventional wisdom, real depreciations have contractionary effects on output. Persistent devaluations have led to high inflation and economic contraction in Turkey. For that reason we have reached the conclusion that foreign trade policy based on the persistent devaluation of real exchange rate will not be efficient to increase export potential of Turkey. Evidences obtained from variance decompositions and impulse response functions imply that tfiere is a very strong pass-through from real exchange rate to inflation. This finding also point out the substantial risks to keep the exchange rate at a competitive level. As a result permanent real devaluation may not be successful unless it is accompanied by appropriate monetary and fiscal policies.
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