Influence of Exchange Rate on the Economic Growth in the Turkish Economy

Özcan Karahan

doi:10.5817/fai2020-1-2

Abstract

The traditional view asserts that there is a positive relationship between the foreign exchange rate and economic growth. So much so that an increase in foreign exchange rates enhances the net export volume and thus positively affects economic growth due to the increasing total demand. However, structural economists argue that there is an inverse relationship between the exchange rate and economic growth. Especially in developing countries, the input structure of production depends on imported capital and intermediate goods, so an increase in exchange rates makes import production inputs more expensive and thus negatively affects economic growth. Turkey, leaving foreign exchange rate free float since 2002, has implemented the Inflation Targeting (IT) regime as the monetary policy. Therefore, Turkey has a real experience to analyse the role of exchange rate changes on economic growth. Accordingly, in our study, using the quarterly data between 2002-Q1 and 2019-Q1, the relationship between exchange rate and economic growth was examined by employing Johansen cointegration test, Granger causality test and Innovation Accounting Techniques. Empirical findings suggest that there is a negative causal relationship between exchange rates and economic growth, as claimed by structuralist economists. In terms of policy implications, it can be argued that, even under the inflation targeting regime in Turkey, both price and exchange rate stability should be provided together.

Highlights

The economic effects of the exchange rate changes are among the most controversial issues in the literature
In order to make a contribution to the debate in the literature indicated above, this study aims to test the arguments that are put forward by classical and structuralist economists related to the link between exchange rate and economic growth, using data belonging to Turkey's economy
We empirically examine the relationship between exchange rate and economic growth in Turkey by Johansen Cointegration Test and Granger Causality Test based on Error Correction Model

Summary

Introduction

The economic effects of the exchange rate changes are among the most controversial issues in the literature. The effect of exchange rate changes on economic growth has become one of the most important research topics over the past decades. Depreciation of local currency after an increase in the exchange rate, by influencing the relative prices of domestic and foreign goods, promotes exports while decreasing imports. The depreciation of the local currency both converts the demands of foreigners into the country and directs the import demands of the indigenous to the local products. That means devaluation can be proposed as an effective policy tool that can be used to stimulate economic growth. Structuralist economists argue that the devaluation policy will have a negative impact on the economies of developing countries. Increasing production costs due to the depreciation of the domestic currency can have a negative impact on the output level

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