Abstract
The main focus of this paper is to examine the impact of the real effective exchange rate on economic growth in Sierra Leone. First an analytical framework is developed to identify the determinants of the real effective exchange rate. Using quarterly data and employing recent econometric techniques, the relationship between the real effective exchange rate and economic growth is then investigated. A bivariate Granger causality test was also employed as part of the methodology to examine the causal relationship between the real exchange rate and economic growth. The empirical results suggest that the real effective exchange rate correlates positively with economic growth, with a statistically significant coefficient. The results also indicate that monetary policy is relatively more effective than fiscal policy in the long run, and evidence of the real effective exchange rate causing economic growth was profound. In addition, the results showed that terms of trade, exchange rate devaluation, investment to GDP ratio and an excessive supply of domestic credit were the main determinants of the real exchange rate in Sierra Leone.
Highlights
The relationship between the real effective exchange rate and economic growth is certainly an important issue, from both the descriptive and policy prescription perspectives
In addition to investigating the effect of the real effective exchange rate (REER) on output growth, the model has the advantage of establishing the relative effectiveness of fiscal and monetary policies on real output growth during the review period
The results of the long run indicate that the REER, monetary policy and fiscal policy all had a positive effect on output growth, while the civil war during the 1990s had an adverse effect on output growth in Sierra Leone during the review period
Summary
The relationship between the real effective exchange rate and economic growth is certainly an important issue, from both the descriptive and policy prescription perspectives. The aggregate supply channel posits that the depreciation of the real exchange rate increases the cost of production (and reduced GDP) and helps redistribute income in favour of the rich While some of these studies argue that real depreciation has expansionary effects on real output growth (Cooper, 1971; Gylfson & Schmid, 1983), others have argued that real exchange rate depreciation has contractionary effects (Edwards, 1989; Agénor, 1991; Morley, 1992). This study examines the relationship between the real effective exchange rate and output growth (GDP) in Sierra Leone. This paper examines the econometric relationship between the real effective exchange rate and RGDP growth in Sierra Leone, a small open economy in sub-Saharan Africa (SSA) which experienced a declining output growth in the 1970s, 80s and 90s.
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