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Abstract

This paper investigates the relationship between economic growth and exchange rate in Sierra Leone for the period 1970-2005. We followed the lead of Edwards (1989, 1988) and Elbadawi (1994) within an error-correction model (ECM) to identify the determinants of the real effective exchange rate, and we specified a real output growth equation to capture not only the effect of real effective exchange rate on real GDP growth, but also to establish the relative effectiveness of fiscal and monetary policy on real output growth during the review period. Our empirical results suggest that the terms of trade, nominal exchange rate devaluation, investment to GDP ratio and excess supply of domestic credit affect the real effective exchange rate in Sierra Leone. In addition, the results of the real output growth show that fiscal policy is relatively more effective than monetary policy in the long run, and that the real exchange rate has a positive effect on real output growth in the long run. The ECM shows that in the short run, real output growth is influenced by money supply and inflation. Furthermore, the estimated results showed that civil/political unrest had adverse effect on output growth and caused the real effective exchange rate to depreciate in Sierra Leone during the sample period.

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