Are Devaluations Contractionary in Small Import-dependent Economies? Evidence from Botswana

Abstract

This study tests the contractionary devaluation hypothesis in the context of a small open import-dependent economy. Using an error-correction model that controls for monetary policy, fiscal policy, base country output and interest rates, the study finds that currency devaluations are contractionary in the long run and expansionary in the short-run. Other results are that increases in government consumption expenditure and base country output are expansionary, while monetary policy has the expected negative output effect.

Keywords: contractionary devaluation, error-correction model, small import-dependent economy