Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa

Pabai Fofanah

doi:doi:10.11648/j.ijber.20221101.15

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Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa

Pabai Fofanah

Published in International Journal of Business and Economics Research (Volume 11, Issue 1)

Received: 13 January 2022 Accepted: 3 February 2022 Published: 16 February 2022

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Abstract

The implications of exchange rate movement for economic growth have become a growing focus of attention in the recent policy debate and the debate concentrate on the degree of volatility in the exchange rate. Exchange rate volatility is usually a risk that will result in higher costs for risk-averse investors, who may adopt a wait-and-see policy until the uncertainty subsides, thereby leading to reduced employment opportunities and slower growth. Thus, in judging the desirability of exchange rate volatility, this paper studies the effects of exchange rate volatility on economic growth for twelve West African countries: The Gambia, Ghana, Cote d'Ivoire, Mali, Niger, Nigeria, Senegal, Togo, Benin, Burkina Faso, Guinea Bissau, and Sierra Leone. Furthermore, the almost complete neglect of the financial sector development in the growth prospect of West African countries is still rather surprising since economic intuition and theory suggest that the growth of the financial sector by means of indebtedness and credit expansion does provide an average GDP growth rate. However, the financial markets and institutions in the West African countries are narrow and shallow. Thus, these countries do not have the tools to hedge exchange rate risks. Hence, fluctuating exchange rates often generate uncertainty, which leads to a decline in economic activity. Therefore, this study also analyzes the role of financial sector development on the impact of exchange rate volatility on economic growth of the West African economies. The random-effects and the two-step difference Generalized Method of Moment GMM estimation techniques are used in this analysis. The “Ad hoc method” is employed by using the lagged term of exchange rate movements for a robustness check in the random-effects model. The results support that the depreciation of the real effective exchange rate volatility has a contractionary effect on economic growth in West African countries and this contractionary effect decreases with countries’ financial sector development. Our results are also support the random effect “Ad hoc methodology” and the GMM procedure implying that they are robust to the cross-section correlation and reverse causality considerations. We also showed that depreciation of real exchange rate is again contractionary for the West African countries in the short run as well as in the long run using GMM procedures. The study recommends that the authorities in the West African countries should speed up the development of their financial sector to decrease the negative effects of exchange rate volatility thereby encouraging economic growth.

Published in	International Journal of Business and Economics Research (Volume 11, Issue 1)
DOI	10.11648/j.ijber.20221101.15
Page(s)	32-48
Creative Commons	This is an Open Access article, distributed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution and reproduction in any medium or format, provided the original work is properly cited.
Copyright	Copyright © The Author(s), 2022. Published by Science Publishing Group

Keywords

Economic Growth, Ad Hoc Methodology, Financial Sector Development, Exchange Rate Volatility, Endogeneity, Heteroskedasticity

References

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Pabai Fofanah. (2022). Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa. International Journal of Business and Economics Research, 11(1), 32-48. https://doi.org/10.11648/j.ijber.20221101.15

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Pabai Fofanah. Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa. Int. J. Bus. Econ. Res. 2022, 11(1), 32-48. doi: 10.11648/j.ijber.20221101.15

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Pabai Fofanah. Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa. Int J Bus Econ Res. 2022;11(1):32-48. doi: 10.11648/j.ijber.20221101.15

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@article{10.11648/j.ijber.20221101.15,
  author = {Pabai Fofanah},
  title = {Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa},
  journal = {International Journal of Business and Economics Research},
  volume = {11},
  number = {1},
  pages = {32-48},
  doi = {10.11648/j.ijber.20221101.15},
  url = {https://doi.org/10.11648/j.ijber.20221101.15},
  eprint = {https://article.sciencepublishinggroup.com/pdf/10.11648.j.ijber.20221101.15},
  abstract = {The implications of exchange rate movement for economic growth have become a growing focus of attention in the recent policy debate and the debate concentrate on the degree of volatility in the exchange rate. Exchange rate volatility is usually a risk that will result in higher costs for risk-averse investors, who may adopt a wait-and-see policy until the uncertainty subsides, thereby leading to reduced employment opportunities and slower growth. Thus, in judging the desirability of exchange rate volatility, this paper studies the effects of exchange rate volatility on economic growth for twelve West African countries: The Gambia, Ghana, Cote d'Ivoire, Mali, Niger, Nigeria, Senegal, Togo, Benin, Burkina Faso, Guinea Bissau, and Sierra Leone. Furthermore, the almost complete neglect of the financial sector development in the growth prospect of West African countries is still rather surprising since economic intuition and theory suggest that the growth of the financial sector by means of indebtedness and credit expansion does provide an average GDP growth rate. However, the financial markets and institutions in the West African countries are narrow and shallow. Thus, these countries do not have the tools to hedge exchange rate risks. Hence, fluctuating exchange rates often generate uncertainty, which leads to a decline in economic activity. Therefore, this study also analyzes the role of financial sector development on the impact of exchange rate volatility on economic growth of the West African economies. The random-effects and the two-step difference Generalized Method of Moment GMM estimation techniques are used in this analysis. The “Ad hoc method” is employed by using the lagged term of exchange rate movements for a robustness check in the random-effects model. The results support that the depreciation of the real effective exchange rate volatility has a contractionary effect on economic growth in West African countries and this contractionary effect decreases with countries’ financial sector development. Our results are also support the random effect “Ad hoc methodology” and the GMM procedure implying that they are robust to the cross-section correlation and reverse causality considerations. We also showed that depreciation of real exchange rate is again contractionary for the West African countries in the short run as well as in the long run using GMM procedures. The study recommends that the authorities in the West African countries should speed up the development of their financial sector to decrease the negative effects of exchange rate volatility thereby encouraging economic growth.},
 year = {2022}
}

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TY  - JOUR
T1  - Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa
AU  - Pabai Fofanah
Y1  - 2022/02/16
PY  - 2022
N1  - https://doi.org/10.11648/j.ijber.20221101.15
DO  - 10.11648/j.ijber.20221101.15
T2  - International Journal of Business and Economics Research
JF  - International Journal of Business and Economics Research
JO  - International Journal of Business and Economics Research
SP  - 32
EP  - 48
PB  - Science Publishing Group
SN  - 2328-756X
UR  - https://doi.org/10.11648/j.ijber.20221101.15
AB  - The implications of exchange rate movement for economic growth have become a growing focus of attention in the recent policy debate and the debate concentrate on the degree of volatility in the exchange rate. Exchange rate volatility is usually a risk that will result in higher costs for risk-averse investors, who may adopt a wait-and-see policy until the uncertainty subsides, thereby leading to reduced employment opportunities and slower growth. Thus, in judging the desirability of exchange rate volatility, this paper studies the effects of exchange rate volatility on economic growth for twelve West African countries: The Gambia, Ghana, Cote d'Ivoire, Mali, Niger, Nigeria, Senegal, Togo, Benin, Burkina Faso, Guinea Bissau, and Sierra Leone. Furthermore, the almost complete neglect of the financial sector development in the growth prospect of West African countries is still rather surprising since economic intuition and theory suggest that the growth of the financial sector by means of indebtedness and credit expansion does provide an average GDP growth rate. However, the financial markets and institutions in the West African countries are narrow and shallow. Thus, these countries do not have the tools to hedge exchange rate risks. Hence, fluctuating exchange rates often generate uncertainty, which leads to a decline in economic activity. Therefore, this study also analyzes the role of financial sector development on the impact of exchange rate volatility on economic growth of the West African economies. The random-effects and the two-step difference Generalized Method of Moment GMM estimation techniques are used in this analysis. The “Ad hoc method” is employed by using the lagged term of exchange rate movements for a robustness check in the random-effects model. The results support that the depreciation of the real effective exchange rate volatility has a contractionary effect on economic growth in West African countries and this contractionary effect decreases with countries’ financial sector development. Our results are also support the random effect “Ad hoc methodology” and the GMM procedure implying that they are robust to the cross-section correlation and reverse causality considerations. We also showed that depreciation of real exchange rate is again contractionary for the West African countries in the short run as well as in the long run using GMM procedures. The study recommends that the authorities in the West African countries should speed up the development of their financial sector to decrease the negative effects of exchange rate volatility thereby encouraging economic growth.
VL  - 11
IS  - 1
ER  -

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Pabai Fofanah

The School of Finance, Central University of Finance and Economics, Beijing, China

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Pabai Fofanah. (2022). Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa. International Journal of Business and Economics Research, 11(1), 32-48. https://doi.org/10.11648/j.ijber.20221101.15

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Pabai Fofanah. Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa. Int. J. Bus. Econ. Res. 2022, 11(1), 32-48. doi: 10.11648/j.ijber.20221101.15

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Pabai Fofanah. Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa. Int J Bus Econ Res. 2022;11(1):32-48. doi: 10.11648/j.ijber.20221101.15

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@article{10.11648/j.ijber.20221101.15,
  author = {Pabai Fofanah},
  title = {Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa},
  journal = {International Journal of Business and Economics Research},
  volume = {11},
  number = {1},
  pages = {32-48},
  doi = {10.11648/j.ijber.20221101.15},
  url = {https://doi.org/10.11648/j.ijber.20221101.15},
  eprint = {https://article.sciencepublishinggroup.com/pdf/10.11648.j.ijber.20221101.15},
  abstract = {The implications of exchange rate movement for economic growth have become a growing focus of attention in the recent policy debate and the debate concentrate on the degree of volatility in the exchange rate. Exchange rate volatility is usually a risk that will result in higher costs for risk-averse investors, who may adopt a wait-and-see policy until the uncertainty subsides, thereby leading to reduced employment opportunities and slower growth. Thus, in judging the desirability of exchange rate volatility, this paper studies the effects of exchange rate volatility on economic growth for twelve West African countries: The Gambia, Ghana, Cote d'Ivoire, Mali, Niger, Nigeria, Senegal, Togo, Benin, Burkina Faso, Guinea Bissau, and Sierra Leone. Furthermore, the almost complete neglect of the financial sector development in the growth prospect of West African countries is still rather surprising since economic intuition and theory suggest that the growth of the financial sector by means of indebtedness and credit expansion does provide an average GDP growth rate. However, the financial markets and institutions in the West African countries are narrow and shallow. Thus, these countries do not have the tools to hedge exchange rate risks. Hence, fluctuating exchange rates often generate uncertainty, which leads to a decline in economic activity. Therefore, this study also analyzes the role of financial sector development on the impact of exchange rate volatility on economic growth of the West African economies. The random-effects and the two-step difference Generalized Method of Moment GMM estimation techniques are used in this analysis. The “Ad hoc method” is employed by using the lagged term of exchange rate movements for a robustness check in the random-effects model. The results support that the depreciation of the real effective exchange rate volatility has a contractionary effect on economic growth in West African countries and this contractionary effect decreases with countries’ financial sector development. Our results are also support the random effect “Ad hoc methodology” and the GMM procedure implying that they are robust to the cross-section correlation and reverse causality considerations. We also showed that depreciation of real exchange rate is again contractionary for the West African countries in the short run as well as in the long run using GMM procedures. The study recommends that the authorities in the West African countries should speed up the development of their financial sector to decrease the negative effects of exchange rate volatility thereby encouraging economic growth.},
 year = {2022}
}

Copy | Download

TY  - JOUR
T1  - Effects of Exchange Rate Volatility on Economic Growth: Evidence from West Africa
AU  - Pabai Fofanah
Y1  - 2022/02/16
PY  - 2022
N1  - https://doi.org/10.11648/j.ijber.20221101.15
DO  - 10.11648/j.ijber.20221101.15
T2  - International Journal of Business and Economics Research
JF  - International Journal of Business and Economics Research
JO  - International Journal of Business and Economics Research
SP  - 32
EP  - 48
PB  - Science Publishing Group
SN  - 2328-756X
UR  - https://doi.org/10.11648/j.ijber.20221101.15
AB  - The implications of exchange rate movement for economic growth have become a growing focus of attention in the recent policy debate and the debate concentrate on the degree of volatility in the exchange rate. Exchange rate volatility is usually a risk that will result in higher costs for risk-averse investors, who may adopt a wait-and-see policy until the uncertainty subsides, thereby leading to reduced employment opportunities and slower growth. Thus, in judging the desirability of exchange rate volatility, this paper studies the effects of exchange rate volatility on economic growth for twelve West African countries: The Gambia, Ghana, Cote d'Ivoire, Mali, Niger, Nigeria, Senegal, Togo, Benin, Burkina Faso, Guinea Bissau, and Sierra Leone. Furthermore, the almost complete neglect of the financial sector development in the growth prospect of West African countries is still rather surprising since economic intuition and theory suggest that the growth of the financial sector by means of indebtedness and credit expansion does provide an average GDP growth rate. However, the financial markets and institutions in the West African countries are narrow and shallow. Thus, these countries do not have the tools to hedge exchange rate risks. Hence, fluctuating exchange rates often generate uncertainty, which leads to a decline in economic activity. Therefore, this study also analyzes the role of financial sector development on the impact of exchange rate volatility on economic growth of the West African economies. The random-effects and the two-step difference Generalized Method of Moment GMM estimation techniques are used in this analysis. The “Ad hoc method” is employed by using the lagged term of exchange rate movements for a robustness check in the random-effects model. The results support that the depreciation of the real effective exchange rate volatility has a contractionary effect on economic growth in West African countries and this contractionary effect decreases with countries’ financial sector development. Our results are also support the random effect “Ad hoc methodology” and the GMM procedure implying that they are robust to the cross-section correlation and reverse causality considerations. We also showed that depreciation of real exchange rate is again contractionary for the West African countries in the short run as well as in the long run using GMM procedures. The study recommends that the authorities in the West African countries should speed up the development of their financial sector to decrease the negative effects of exchange rate volatility thereby encouraging economic growth.
VL  - 11
IS  - 1
ER  -

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