Macroeconomic Effects of Currency Devaluation: A Case Study of Bangladesh

Abstract

The hypothesis of contractionary effects the devaluation have been tested within the help of a small macroeconometric model of the economy of Bangladesh. Although highly contractionary supply-side effects are observed, devaluation has been found to expand output modestly through the demand side. Devaluation, however, improves the current account of the balances of payments. A devaluation cum credit contraction improves trade balance; however, the accompanying hazards are contraction in output, consumption, investments, export, and import on the one hand, and an alarming high proportionate rise in price level, on the other. In other words, devaluation-cum-credit-contraction is stagflationary. The redistributive effects of a stereotype devaluation0based stabilization policy may prove to be destabilizing for a very poor country.

The best policy option should not be maxi-devaluation but unceasing vigilance of the policy authority so as to correct any tendency of the currency towards being overvalued. The latter in turn would require well-synchronized and mutually consistent macroeconomic policies.