Devaluation and Output Growth: Evidence from Pakistan

Abstract

This article investigates the long run and short run effect of currency devaluation on output growth of Pakistan by
applying unit root and cointegration analysis. The data set includes annual observations for the period 1980-2009. Moreover, this
study examines four alternative but equally plausible hypotheses, each with different policy implications. These are: i) Real GDP cause
Real Effective Exchange Rate (the conventional view), ii) Real Effective Exchange Rate cause Real GDP, iii) There is a bi-directional
causality between the two variables and iv) Both variables are causality independent (although highly correlated). The empirical evidence
finds significant positive relationship between devaluation and output growth in long run, as well as in short run. Both in the long and
short run, output growth are affected by currency devaluations.