The effect of real exchange rate changes on output: Jamaica's devaluation experience

Abstract

Developing economies have relied upon devaluation to assist in the correction of fundamental disequilibrium in the balance of payment. As posited by conventional economic theory and proven by empirical research, a devaluation improves the balance of payments by reducing the demand for imports and increasing the supply of exports. However, recent research on devaluation insists that correction of the trade deficit occurs concurrently with income reduction. Using a three‐market Keynesian model, the conclusion reached in this research on the Jamaican economy is that a devaluation is contractionary in the short run and expansionary in the long run.

Revisiting the exchange rate debate: the Jamaican experience

“…The cointegration analysis of the relationship between real GDP and real exchange rate raises questions about the validity of a simple reduced form equation for GDP in a small open economy. The estimations produced notably dierent results from Edwards (1986) and Rhodd (1993) and suggests that these earlier analyses which failed to take account of the non-stationarity of the variables yielded spurious regressions. Thus Edward's study of 12 countries and Rhodd's study of Jamaica both claimed that devaluation was contractionary in the short run but expansionary in the long run.…”

“…The current paper however, drops the Terms of Trade variable included by Rhodd partly because it does not seem to be an independent policy variable distinct from the real exchange rate and partly because Rhodd (1993), Edwards (1983) and Barro (1979) found no signi®cant eect on real output, and therefore dropped it from their estimated equations. Although inclusion of a time trend could sometimes be of use, in the case of Jamaica it was dropped, because for GDP (1960±93) there appear to be three distinct trends (Figure 1).…”

“…The estimation is based on annual data for 1960±93, (World Bank, 1994) and following Rhodd (1993), uses the government expenditure ratio as an indicator of ®scal stance, and the domestic credit ratio as an indicator of the monetary policy. In the estimation it would be expected that b 2 , b 3 4 0, the b 1 coecient captures the eect of real devaluation on output, if devaluations are contractionary this should be negative.…”

“…The subsequent empirical analysis diers from Rhodd (1993) study of the impact of devaluations in Jamaica since it uses new time series techniques to identify a cointegrating relationship. These results are then used to discuss the long and short run impacts of devaluation and also to brie¯y comment on the structural susceptibility of Jamaica to Dutch Disease eects arising out of its dependence on bauxite.…”

The impact of exchange rate adjustment on output: Jamaica 1960–90

“…This paper provides estimates of the impact of devaluation on output in Jamaica using an extended version of the approach developed by Khan and Knight (1981), Edwards (1986) and Rhodd (1993).…”