Why Are Crisis-Induced Devaluations Contractionary? Exploring Alternative Hypotheses

Abstract

Why are some currency crises followed by economic contractions while others are not? This paper is an attempt at answering this query. In particular, we investigate two closely related questions. First, we explore whether there is a difference in the output effects of a devaluation during “normal” periods versus crises ones; after all, during non-crisis periods, real exchange devaluation is seen as an important policy option for promoting exports and output growth. Yet, the literature has not made a distinction between crisis and non-crisis periods. To preview the main conclusion, we find that the contractionary effects tend to exist only during the crisis period. Building on this, we go on to explore the factors that cause a crisis-induced devaluation to be contractionary.