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Impact of Exchange Rate on Economic Growth


INTRODUCTION Impact Of Exchange Rate On Economic Growth

Pakistan is a open economy and therefore is prone to both external and internal shocks which can destabilize her economy. Pakistan being a developing country is faced with the challenge of designing policies to economic growth and mitigating challenges arising from the implementation of both microeconomic and macroeconomic policies. These policies range from fiscal policy, monetary policy to exchange rate policy. Exchange rate plays an important role in countries’ economy which relates on the economies through international relationships. In the view of macroeconomics aspect, the exchange rate means that the price of a country’s currency in terms of another country’s currency. The exchange rate is classified into both real and nominal exchange rates which formulates the inflation rate. In the exchange rate, if the inflation rate is excluded, it is called real exchange rate. In the meantime, if the inflation rate is included into the exchange rate, which is called nominal exchange rate.

The exchange rate as was been defined by Mordi, (2006) as the price of one currency in terms of another. The increase or decrease of real exchange rate indicates the strength or the weaknesses of the currency in relation to foreign currency, and it is a standard for illustrating the competitiveness of domestic industries in the world market. The terms depreciation and devaluation are used in floating and fixed exchange rate regimes respectively, when currency loses its value against foreign currency.Floating exchange rate allows the central banks to exercise more independent monetary policy, which is crucial to control the economy. There are different approaches which discussed devaluation, namely elasticity approach, monetary approach and absorption approach. Depreciation may affect different macroeconomic variables and can influence economic agent decision. The gross domestic product (GDP) is one the primary indicators used to determine the health of a country’s economy. For example, if the year-to-year GDP is up 3%, this is thought to mean that the economy has grown by 3% over the last year. Economists have long known that poorly managed exchange rates can be disastrous for economic growth.

Importance of the study

The foreign exchange rate is determined independently to the economic growth rate. The exchange rate can have an influence on economic growth. And the economic growth rate can influence the exchange rate..

Strong Exchange Rate

A strong exchange rate is often considered to be a sign of economic strength. It can become a symbol of national pride. Often politicians are worried if they see a ‘weakening’ in the exchange rate. They will point to a strong exchange rate as a symbol of economic success.

In the long-term, a strong (appreciating) exchange rate tends to occur in countries with low inflation, improving competitiveness and a strong economic performance. For example, Japan and Germany saw a sustained rise in their exchange rates in the post-war period because they had a good economic performance.

In the short-term, a strong exchange rate could be due to a variety of other factors. For example, the Swiss France recently appreciated because it was seen as a relative safe haven compared to the Euro zone currencies. Short speculation rather than long-term economic improvement.-term movements in the exchange rate can be misleading to the overall economic situation because it might be driven by

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