Macroeconomic Policy and Exchange Rate Policy Management in a Small Dependent Economy: Estimating the Effects of Currency Devaluation in Jordan

Ole Risager and William G. Tyler

No 96-08, EPRU Working Paper Series from Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics

Abstract: This paper addresses the question of the possible real side effects of exchange rate devaluation in a small dependent economy, with a specific empirical application to Jordan. A macroeconomic model is constructed on the basis of a number of stylized facts which characterize the Jordanian economy. These characteristics include: a high dependence on foreign inputs in production; limited substitutibility between domestic and imported inputs; high external indebtedness and debt servicing requirements, all of which are denominated in foreign exchange; an excess supply of labour and stickiness in wages; and a high dependence on labour remittances. Jordanian data are fit to the model, along with the estimation of some parameter values. The model is then used to simulate policy changes. An exercise undertaken with a resultant reduction in the current account deficit, increased gross output and reduced unemployment.

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