Effectiveness of Devaluation in Achieving Internal and External Balance: The Case of Ethiopia
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Date
2015-06
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Addis Ababa University
Abstract
Currency devaluation is a policy instrument that is most accepted and recommended by the World Bank and the International Monetary Fund because it is believed to bring the devaluating country to be able to compute in the international market and achieve trade balance. This study analyzes the effectiveness of devaluation in achieving Internal and External balance in Ethiopia using annual time series data for theexternal balance from 1974-2014and for the internal balance from 2006/7-2015. The main focus of the internal balance analysis will be the recent devaluation especially the 2009/10 and 2010/11 devaluations and forboth internal andexternalbalance analysis this paper is going tosee the effects of devaluation since 1992 up until 2014. This study usedVARand tested the short andlong run effects of exchange rate depreciation and devaluation, real GDP and Real Effective Exchange Rate on trade balance. With the second model, impacts of real effective exchange rate on inflation was also tested along with different variables. Internal balance is analyzed by using descriptive technique to show what effect devaluation hason it. This study found that real effective exchange rate has a negative impact on inflationary situations both in the short and long run. In additiondevaluation’s effect on trade balance or external balance was found to be negatively related in the short run but positive in the long run. But the significance of real effective exchange rate in affecting trade balance is going to be very low in the long run.All in all this study has discoveredthat devaluation/depreciationis effective in achieving internalbalance but might not be effective in achievingexternal balance.
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Devaluation in Achieving Internal and External Balance