Exchange Rate and Real Output Within a SVAR Framework: Empirical Evidence from Egypt

This paper analyzes the effect of exchange rate changes on the economic performance in Egypt. Analyzing the effect of exchange rate fluctuations on output in Egypt has been increasingly imperative in the wake of Egypt uprising of 2011 and the subsequent depreciations of the Egyptian pound which ended up with the decision to liberalize the foreign exchange market in 2016. Toward the purpose of the paper, a Structural Vector Autoregression (SVAR) Blanchard-Quah model is constructed using quarterly data for Egypt over the period 2005–2016. This method imposes restrictions on the long-run response of variables to the structural shocks. Such restrictions are believed to be more consistent with the general agreement on the long-run properties of economic theory. The impulse response functions (IRFs) and forecast error variance decompositions (FEVDs) are customary tools to investigate the direction and magnitude of the impact of devaluation on output. The findings of this paper support the significant effect of changes of the exchange rate on real output. The results reveal an initial expansionary effect of devaluation on output that turns to be short-lived contractionary impact. Macroeconomic policies prove to have a positive and significant effect on output. The results confirm the small magnitude of the fiscal multiplier effect on output. In addition, fiscal and monetary policies have a significant effect on exchange rate but with opposite directions.