Academic journal article Seoul Journal of Economics

The Role of Foreign Exchange Rates in Sub-Saharan Countries: Empirical Comparison with Non-Euro OECD Countries Using Panel Data

Academic journal article Seoul Journal of Economics

The Role of Foreign Exchange Rates in Sub-Saharan Countries: Empirical Comparison with Non-Euro OECD Countries Using Panel Data

Article excerpt

(ProQuest: ... denotes formulae omitted.)

I.Introduction

Exchange rates are the necessary link between domestic economies and foreign economies. They play a very important role in contributing to the determination of exports, imports, trade balances, and GDP of all countries. This role is well documented in the relevant literature (both theoretically and empirically) and needs no evidence in this paper (although indirectly we talk about this issue as seen in the paragraphs which follow below). However, this role is not clear cut; it depends on several factors such as stage of economic development, import or export substitution, and so on.

In this paper, we want to examine a particular region of the world, the Sub Saharan Africa (SSA), which is still one of the poorest areas. We want to see the role of exchange rates in the economic development of this region through foreign trade for five main reasons. First as we will see in the next section there is a theoretical controversy regarding the effectiveness of devaluations/depreciations on trade balances and outputs. Hence strong empirical evidence might provide us a more definite theoretical answer to this controversy. Second, only a few studies have been conducted for this region (SSA) in this respect, and the conclusions have not been clear cut.

Third, we want to use four econometric models of panel data for providing rigorous empirical evidence; this is also a novelty of our paper which will add more robust conclusions in the existing literature for developing countries such as the SSA ones. Fourth, we will examine both trade balances directly and indirectly through exports and imports separately (another novelty). Finally, another important contribution of our paper is the econometric comparison between the SSA nations and a good sample of the non-Euro OECD developed countries. With this comparison we might be able to discern eventual differences in the effect of devaluations between developing and developed nations; these differences will in turn elucidate some theoretical considerations. All these five contributions make our paper a substantial addition to the existing relevant literature.

Developing countries such as the SSA ones face continuous problems regarding trade deficits and often low growth rates. These SSA nations have been using the policy tool of exchange rates to boost exports or to curtail imports and to accelerate their economic growth. In particular they often devalue their currency in order to boost exports and grow faster. This devaluation takes place mainly under the regime of highly managed floating rates (IMF 2004 classification) and hence we will use the term depreciation only for the freely floating rates of developed countries as this term is established in the literature.1

Did these devaluations succeed? Did they improve trade balances? Were they the right policy? Did they have expansionary effects on output? For example, under the flag of liberalization for the last three decades in SSA countries their trade balances worsened (Agbeyegbe et al. 2004; Freund, and Rocha 2011), although their GDP was growing. International organizations such as the World Bank (WB) and International Monetary Fund (IMF) suggested more reforms including further devaluations of domestic currencies. Were these suggestions correct? Our paper will attempt to provide some answers to these questions.

Consequently, we will test the following specific hypotheses:

i) Exchange rates have a definite positive effect increasing real and nominal output; increasing exports and reducing imports; and reducing trade balance deficits in SSA countries;

ii) This effect is much stronger for non-Euro Zone OECD countries than SSA countries.

The remaining paper is as follows. In section II we summarize some theoretical and empirical articles in the literature. In section III we present the data, equations to be estimated, and the econometric models to use. …

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