Are Devaluations Expansionary or Contractionary? A survey article

Abstract

Earlier studies that investigated the impact of devaluation on domestic production relied upon the aggregate demand analysis. They argued that by making a country’s exports cheaper and imports expensive, devaluation is said to stimulate the aggregate demand and thus, domestic production. In this case, devaluation is said to be expansionary. Recent studies, however, have argued that by raising the cost of imported inputs, devaluation contracts aggregate supply. If decrease in aggregate supply more than offsets the increase in aggregate demand, output eventually declines. In this case, devaluation is said to be contractionary. This article reviews the existing research on the effects of devaluation on domestic production and concludes that the impact is country specific and depends on model specification and results depend on the estimation technique.