The Impact of Exchange Rate Volatility on Long-term Economic Growth: Insights from Lebanon

Abstract

There is ongoing debate in empirical research regarding the impact of exchange rate volatility on exports and economic growth. While some studies argue that exchange rate volatility positively influences these economic variables, others suggest negative or negligible effects. This study seeks to clarify this debate by examining the specific impact of exchange rate volatility on the economic growth of Lebanon, utilizing annual time series data spanning from 1980 to 2023. In our investigation, we employed several econometric techniques to analyze the relationship between exchange rate volatility and economic growth. Notably, we utilized the autoregressive distributed lag model to explore both the short-term and long-term dynamics between these variables. Our results reveal a nuanced relationship: in the long run, exchange rate volatility exhibits a positive and significant effect on economic growth, while in the short run, this relationship is negative and insignificant. Further analysis identified that variables such as exchange rate volatility, investment volatility, agricultural value-added, and services value-added significantly impact economic growth in the long run. In contrast, inflation and exchange rates were found to have an insignificant effect on long-term economic growth. Specifically, inflation displayed a negative and insignificant relationship with economic growth, suggesting that while inflation can hamper growth, its impact is not statistically significant in this context. Given the inherent challenges in eliminating exchange rate volatility, our study recommends that the government of Lebanon adopt efficient macroeconomic policies aimed at mitigating the adverse effects of currency volatility. These policies should focus on enhancing economic stability and fostering a conducive environment for sustainable growth. Our findings contribute to the broader discourse on exchange rate volatility and its economic implications, offering specific insights relevant to Lebanon and potentially applicable to other economies with similar characteristics. Policymakers can leverage these insights to design strategies that balance the benefits of exchange rate flexibility with the need to protect the economy from excessive volatility. The evidence provided enhances our understanding of the long-term and short-term effects of exchange rate fluctuations, offering a foundation for informed policy-making that promotes economic resilience and growth.