The impact of real effective exchange rate devaluation on macroeconomic indicators

By Vo Thanh Luan (VNP 24)

Supervisor: Dr. Vo Hong Duc

Abstract:

This dissertation examines the impact of real effective exchange rate devaluation on major macroeconomic indicators including trade balance, inflation, foreign direct investment inflows, and gross domestic product. The study aims to answer the central question, “How is each macroeconomic indicator impacted when a country devaluates its currency?”
The sample of nine emerging Asian countries, including India, Indonesia, Jordan, Korea, Malaysia, Pakistan, the Philippines, Thailand, and Vietnam is used. The annual time series data were collected over a period from 1996 to 2019. This study uses the panel vector autoregression (PVAR) approach within a generalized method of moments (GMM) framework to investigate the relationship between these macroeconomic indicators dynamically using the impulse response functions and variance decomposition.
Our empirical findings suggest that currency devaluation will boost the trade balance while also improves output growth. However, the negative consequence is that currency devaluation will result in an increase in inflation. The results also reveal that the currency devaluation is the most important element in explaining inflation fluctuations. In addition, the positive impact of currency devaluation on attracting foreign direct investment is found. Moreover, findings confirm that macroeconomic factors such as the balance of trade, FDI inflows and consumer price index explain significantly the change in exchange rate.
On the ground of these empirical findings, policy implications have emerged. As a result, we consider that it is necessary to put the exchange rate in the context of the interplay with other macroeconomic indicators in order to manage the exchange rate. We recommend that it is necessary to pursue the objectives of stabilizing the exchange rate and controlling inflation. These objectives should be taken into consideration in order to improve the purchasing power of the currency in contrast to other foreign currencies.