ECONOMICS

 

Real exchange rate behaviour and economic growth: Evidence from Sierra Leone

 

 

Abu Bakarr Tarawalie

Department of Economics, University of Sierra Leone

 

 

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ABSTRACT

The main focus of this paper is to examine the impact of the real effective exchange rate on economic growth in Sierra Leone. First an analytical framework is developed to identify the determinants of the real effective exchange rate. Using quarterly data and employing recent econometric techniques, the relationship between the real effective exchange rate and economic growth is then investigated. A bivariate Granger causality test was also employed as part of the methodology to examine the causal relationship between the real exchange rate and economic growth. The empirical results suggest that the real effective exchange rate correlates positively with economic growth, with a statistically significant coefficient. The results also indicate that monetary policy is relatively more effective than fiscal policy in the long run, and evidence of the real effective exchange rate causing economic growth was profound. In addition, the results showed that terms of trade, exchange rate devaluation, investment to GDP ratio and an excessive supply of domestic credit were the main determinants of the real exchange rate in Sierra Leone.

Keywords: Economic growth, real effective exchange rate, Johanssen Cointegration, Sierra Leone

JEL: E63, F31, 41, 43

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Accepted January 2010

 

 

Endnotes

1 The real exchange rate is the nominal exchange rate (index) adjusted for price changes in the domestic economy relative to those of trading partners (Fosu, 1992); that is, RER = EP*/P, where RER is real exchange rate, E is nominal exchange rate, P* is foreign price level, and P is domestic price level.
2 See World Bank country briefing.
3 Bank of Sierra Leone Bulletin. 1997: 20.
4 The leone (Le) is the domestic currency denomination in Sierra Leone.
5 Devaluation involves a reduction in the value of the domestic currency vis-à-vis the currencies of its trading partners.
6 The model consists of exportable goods, importable goods and non-tradable goods (see Dorbusch, 1974).
7 Note that Δln reert = ln reert - ln reert-₁
8 A negative sign implies the impact of a given variable on the REER and leads to an appreciation of the real effective exchange rate, while a positive sign means that the effect of a variable causes a depreciation of the REER.
9 The reert is weighted by the trade shares of exporting partners, and this is computed as:
where i represents the four major export partners of Sierra Leone, αi. is the weight or share of the ith country in the total export of Sierra Leone, CPIi* is the consumer price index of the ith country, ei is the bilateral nominal exchange rate defined as leones per currency of the ith country, CPI is the domestic consumer price index.
10 Terms of Trade = (Export price index/ import price index)*100.
11 OPEN = (X+IM)/GDP, where X is export and IM is import.
12 Beta coefficient (ß) of a variable is defined as follows: ß = (coefficient of the variable * standard error of the variable)/standard error of the regression. A higher beta coefficient means a stronger influence of that variable on the dependent variable. A lower beta coefficient means a weaker influence of the variable on the dependent variable.
13 Countries of the WAMZ include Gambia, Ghana, Guinea, Nigeria and Sierra Leone.