Supply-side effects of exchange rates, exchange rate expectations and induced currency depreciation
Within the context of a small open economy model, this paper examines the repercussions of induced currency depreciation. The results presented in this paper are based on a model with firm microeconomic foundations and which takes into account both the supply and demand-side effects of exchange rate variations. The distinguishing feature of the model is the role of exchange rate expectations. We consider three kinds of expectations; adaptive, extrapolative, and regressive expectations. We also perform several sensitivity tests based on these expectations. Our simulation exercise shows that the effect of induced currency depreciation depends largely on supply-side effects. In most cases, we find that currency depreciation results in (i) a fall in output, (ii) an increase in prices and (iii) an improvement in the balance of trade. In the absence of weak supply-side effects of exchange rates, we find that, if the Marshall-Lerner conditions hold, then depreciation of the home currency has a favorable effect on output but its effect on the balance of trade is negative.
Year of publication: |
2011
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Authors: | Ali, Syed Zahid ; Anwar, Sajid |
Published in: |
Economic Modelling. - Elsevier, ISSN 0264-9993. - Vol. 28.2011, 4, p. 1650-1672
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Publisher: |
Elsevier |
Keywords: | Currency exchange rates Balance of payments Exchange rate expectations |
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