Growth and the Real Exchange Rate - Evidence from Eleven Countries

Mark Crosby, Glenn Otto
2001 Social Science Research Network  
The conventional view about exchange rate depreciations is that the resulting rise in import and export prices induces a switch in expenditures towards home-produced goods, and hence a rise in output. There are, however, a number of plausible alternative views on the effects of exchange rate depreciations. "Contractionary depreciation" models argue that there are a number of channels through which an exchange rate depreciation can reduce output. Early work focused on the impact of a
more » ... on the distribution of income and thereby on aggregate expenditure in an economy. One argument was that a depreciation would lead to a transfer of income from workers, who receive a fixed nominal wage, to capitalists. With capitalists assumed to have a higher propensity to save than workers, this transfer will lead to a decline in demand, and hence to a decline in income. Another argument is that a depreciation can increase the cost of imported capital goods. If there are no close substitutes for the imported capital goods, firms will face rising input costs and an increased need for credit. If credit is rationed or only available at very high interest rates firms may choose to restrict output. Hence depreciations can reduce the supply of output, as well as reducing output through the demand side channels emphasised above.
doi:10.2139/ssrn.1009396 fatcat:3yaz37kasredbdxkpu6y4fmxfm