Are Devaluations Contractionary?

25 Pages Posted: 15 Jun 2001 Last revised: 1 Aug 2022

See all articles by Sebastian Edwards

Sebastian Edwards

University of California, Los Angeles (UCLA) - Global Economics and Management (GEM) Area; National Bureau of Economic Research (NBER)

Date Written: August 1985

Abstract

Recently a number of authors have criticized the role of devaluations in traditional stabilization programs. It has been argued that, contrary to the traditional view, devaluations are contractionary, and generate a decline in aggregate output. In spite of the renewed theoretical interest in the possible contractionary effects of devaluations, the empirical evidence on the subject has been quite sketchy. In this paper the Khan and Knight (1981)model is extended to empirically address the issue of contractionary devaluations. The extended model considers the effect of money surprises, fiscal factors, terms of trade changes and devaluations on the level of real output. The results obtained, using a variance components procedure on data for 12 developing countries, provide some support to the short-run contractionary devaluation hypothesis; the results obtained indicate that in the short-run a devaluation will generate a decline in aggregate output. It is also found that after one year a devaluation will have an expansionary effecton output. The evidence suggests that in the long run, devaluations will have no effect on output.

Suggested Citation

Edwards, Sebastian, Are Devaluations Contractionary? (August 1985). NBER Working Paper No. w1676, Available at SSRN: https://ssrn.com/abstract=273577

Sebastian Edwards (Contact Author)

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