The researched article “The Effect of Devaluation on Output in the Egyptian Economy: A Vector Autoregression Analysis” outlines the interrelationship between exchange rate fluctuations and output in the Egyptian economy. The methodology of the study deploys a Vector Autoregression model based on annual figures over 1982-2004. The outcomes of the study on Egypt economy indicate that devaluations pose an initial contractionary effect on the national output. The contractionary effect continues for four years until devaluation shows positive effects. In the case of Egypt, real output changes directly depend on real exchange rate fluctuations. Considering this, currently the government cannot let market forces to determine the value of the national currency at their discretion. This provides a room for interventions required to correct erroneous steps in designating the exchange rate. Such state of affairs will last until the economy fully transits to the new flexible exchange rate system. Therein, the government’s monetary policy will have a decisive role on economic stabilization.
The study is empirically testing the correlation between exchange rate fluctuations and output in Egypt. The correlation is of a significant strategic importance following the Egyptian government’s decision in January 2003 to let the Egyptian pound float freely, which had caused its subsequent depreciation. By switching to a floating exchange rate regime, the government actually allowed the domestic market forces to determine and change the national currency rate. Free floating assumes a greater extent of currency fluctuations. Consequently, pursuing the correlation between exchange rate changes and economic output in Egypt is vital to comprehend whether the effects of devaluations on the national economy are expansionary or contractionary.
The research findings suggest that changes in the real exchange largely determine the variations in the growth rate of the Egypt’s economic output. The outcomes of the study also favor an initial contractionary effect of devaluation on output continuing within a four-year span prior to positive effects of devaluation take place. The study proves that real exchange rate changes favor economic output while 45-68% of the changes in the rate of growth of output are due to real exchange rate variations. This correlation suggests that the government should not have allowed market forces to determine the value of the national currency in a free fashion. This conclusion calls for imposing interventions to balance improper tendencies in Egypt’s real exchange rate. Such a move is strategically important during the current period until the economy fully transits to the newly-adopted flexible exchange rate system. Therein, the monetary policy will play a bigger role in stabilizing the national economy. At that, much will depend on the development and implementation of a sound monetary policy and institutional capacity of the Central Bank of Egypt.
Devaluations produce an expansionary effect on output within the long lag, meaning that currency depreciations do not come as a quick remedy to overcome recessions. Neither should government deploy consecutive short-run depreciations of the currency while they cause a sustained negative impact on real output delaying the anticipated positive effect. The outcomes of the study also suggest taking measures to shorten the period of the contractionary effect. Overall, the slow adjustment of output is mainly because Egyptian imports and exports fail to react to the changes in the relative prices provoked by devaluations. Thus, Egypt should develop export sector, intensify the response of its exports to market changes, as well as diversify and enhance the quality of its products. Most importantly, it is essential to remove the bureaucratic hindrances restricting the potential of the national export sector (Abdel-Haleim, 2008).
- Abdel-Haleim, S.M. (2008). “The Effect of Devaluation on Output in the Egyptian Economy: A Vector Autoregression Analysis”, International Research Journal of Finance and Economics, Issue 14.