Should developing countries use currency depreciation as a tool of balance of payments adjustment? A review of the theory and evidence, and a guide for the policy maker

Abstract

The use of currency depreciation as a means of strengthening the balance of payments has long been a contentious issue amongst developing countries, especially in their negotiations with the IMF. This article reviews the various ways in which depreciation might exert its impact. A study of the empirical evidence suggests that it may be both an effective and cost effective instrument in many developing countries, even though exceptions do exist. Compared with alternative balance of payments policies, use of the exchange rate emerges as possessing many advantages. It is concluded that greater emphasis should be placed on the exchange rate in the context of IMF programmes than has perhaps been the case in recent years.

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