1.

INTRODUCTION

One of the most important aspects of modern business practice is international trade. It helps
improve international relations by creating personal and business relationships. It is an
extension of the skill base as well as the educational and cultural diversity of people. The
issue of currency exchange rates is at the heart of international trade.

The choice of exchange rate regime has been one of the major issues in the exchange rate
literature. Among the most controversial issues in the literature are the economic effects of
exchange rate changes. In particular, the effect of exchange rate changes on the growth of
the economy has become one of the most important topics of research in the past few
decades. According to the traditional view, it is argued that there is a positive relationship
between exchange rate changes and economic growth.

Accordingly, local currency depreciation after exchange rate appreciation, by affecting

relative prices of domestic and foreign goods, promotes exports and reduces imports. In
other words, depreciating the local currency both redirects foreign demand into the country
and redirects domestic demand to import local products.

As a result, an increase in the exchange rate is supportive of economic growth through the
promotion of net exports. The implication is that devaluation can be proposed as an effective
policy tool that can be used for the stimulation of economic growth.

Conversely, structuralist economists argue that devaluation policy will negatively affect
developing countries' economies. This is because the phenomenon of foreign dependence is
one of the most important structural problems in the economies of developing countries.

Most of the inputs that are used by such countries, especially in their production processes,
are made available through imports. Most of the inputs that these countries use, especially
in the manufacturing process, have to be imported.

Therefore, the cost of imported inputs such as machinery and intermediate goods used in the
production process will increase as the exchange rate rises. Thus, output levels can be
adversely affected by rising production costs due to the depreciation of the domestic
currency.
Concerns about exchange rate volatility are largely due to its impact on exports, employment
growth, foreign trade, inflation, investment and growth in both developed and emerging
economies. There are several channels through which exchange rate volatility can affect
investment and growth. Depending on the assumptions, the sign of the relationship can
theoretically vary.

A large body of research supports the hypothesis that an increase in exchange rate volatility
is associated with a decline in international trade flows and economic growth. This is
because the currency of the exporting or importing country is used to denominate the traded
goods in most international transactions.

Therefore, due to their impact on profits, unexpected changes and volatility in exchange
rates should negatively affect international trade flows and economic growth. Obstfeld and
Rogoff's (1995) theoretical work shows that exchange rate volatility costs domestic
economies through direct and indirect effects on households and firms. The former effect
assumes that households are dissatisfied with exchange rate fluctuations because of the
difficulty of smoothing consumption and fluctuations in leisure consumption. However, the
indirect effect is based on the premise that firms set higher prices in the form of a risk
premium in an attempt to hedge the exchange rate risk (Alagidede et al., 2016).

In contrast, some research suggests that exchange rate volatility is beneficial for
international trade and economic growth. Those favoring this hypothesis argue that flexible
and more volatile exchange rates allow countries to respond to asymmetric shocks, thereby
stimulating economic growth. They also assume that volatility also reduces the possibility
of speculative attacks and is a preventive measure against financial crises. The impact of
exchange rate volatility on international trade and economic growth continues to be debated
in light of these contradictions.

STATEMENT OF THE PROBLEM

In the studies that deal with the negative effects of exchange rate uncertainty, it is argued
that these effects are realized through the following channels (Demir, 2013). These include:
reducing the availability of credit from the banking system by having a contractionary
impact on employment and investment, especially in countries with lower levels of financial
development; reducing productivity growth and aggregate growth; reducing employment
and growth by increasing inflation uncertainty; adversely affecting growth by increasing
interest rates; and damaging firms' balance sheets and net worth.
The impact of exchange rate volatility on growth depends on firm and country
characteristics, given these transmission channels. For example, exchange rate volatility will
have less impact on countries and firms with low risk and high creditworthiness, which have
easy access to domestic and international capital markets.

In general, due to shortcomings in the fiscal and financial structure, exchange rate volatility
has a greater impact in developing countries. These countries are vulnerable to the negative
effects of exchange rate volatility due to the low level of financial deepening and the lack of
financial protection instruments. Using dual currencies in contracts and transactions or
pegging price increases to the dollar, which is also known as dollarization, further
exacerbates the effects of exchange rate volatility. As an important tool for dealing with
asymmetric shocks, flexible exchange rates have been recognized.

This is because exchange rate adjustments are achieved through relative price and
productivity changes, as adjustments in fixed exchange rate regimes are slow and costly due
to price and wage rigidities. Lower growth performance is the result.

On the other hand, McKinnon (1963) emphasized the advantages of fixed exchange rate
regimes for small and open economies in the face of nominal shocks. Exchange rate stability
also ensures domestic price stability in small and open economies because traded goods have
a high share of domestic consumption.

Macroeconomic stability, which provides a favorable environment for investment,

consumption and growth, is the source of the welfare effect of fixed exchange rates. In this
respect, the monetary policy and the exchange rate policy are considered to be the source of
uncertainty and volatility in small open economies. When exchange rate fluctuations are
smoothed, we can say that growth accelerates.

Between 1978 and 2021, Turkey has experienced different exchange rate regimes. The
period between 1978 and 1988 is a period when the real exchange rate was continuously
depreciated in order to make Turkish goods more competitive in international markets,
increasing exports and reducing imports.

During this period, the devaluation of TL was higher than the inflation differential and the
real exchange rate was continuously reduced. Turkey depends on imports of raw materials
and intermediate goods in its production structure. Therefore, in order to reduce the current
account deficit, exports are promoted. However, making the fight against inflation more
difficult has been the main disadvantage of using the exchange rate to promote exports.
Domestic prices of imported raw materials and intermediate goods rose with high TL
depreciation, which raised domestic producer and consumer prices by increasing production
cost.

At the end of the 1970s, the Central Bank started to use the exchange rate as a tool in the
fight against inflation due to the risk of an uncontrollable rise in inflation. Thus, during this
period, the devaluation of the TL is kept low and the real exchange rate continues to rise.

During the fixed/controlled exchange rate regime between 1978 and 2001, the real exchange
rate appreciated continuously. In March 2001, Turkey adopted a floating exchange rate
regime.

Between 2001 and 2008, the real exchange rate followed an appreciating trend until 2008,
which was gradually replaced by a depreciating trend following the 2008 crisis.

Turkey's economy was subject to considerable instabilities, including significant

fluctuations in exchange rates and two major banking crises, which occurred in 1994 and
2001.

The real exchange rate has fallen to 58, which is its historical low, after the large devaluation
of the Turkish lira in the 1994 crisis. Therefore, using exchange rate as a policy instrument
to fight inflation or current account shortfall have increased exchange rate volatilities in
Turkey.

The imbalance of foreign capital inflows with the changes in global economic conditions
also affects the exchange rate volatility in Turkey under the floating exchange rate regime.
Therefore, the impact of exchange rate on economic growth in Turkey between 1978 and
2021 is examined in this study.

In order to fulfill the above objectives, hypotheses have been formulated which have to be
answered by the respondents throughout the research. The hypotheses are the following:

• H1: There are a relation between GDP and exchange rate

• H2: The relation between GDP and exchange rate is positive or negative
• H3: Long-run or short-run provide between the variables
 2. LITERATURE REVIEW

2.1. EXCHANGE RATE

2.1.1. EXCHANGE RATE DEFINITION
The price of one nation's currency in relation to another nation's currency is called the
exchange rate (Mankiw, 2013). For example, how many Turkish Lira are needed to buy $1
USD? The implication is that one should consider the exchange rate before any economic
transaction such as investment decision, trade, etc., as can be seen from both the definition
of exchange rate and the following guiding questions. Much attention has been given to
discussing the impact and relationship of the exchange rate with other macroeconomic
indicators, as it is an essential position in the economy.

2.1.1.1. Direct Quoting of the Exchange Rate

A direct quotation is a type of quotation that expresses the prices of the domestic currency
or the domestic currency in terms of a foreign currency (Investopedia, 2021). In other words,
in the direct quotation system, it's asked the literal load of domestic currency desired to
acquire a unit of foreign currency. The foreign currency is the base currency and the
domestic currency is the quoted currency in the direct or direct quoting system.

2.1.1.2. Indirect Quoting of the Exchange Rate

Indirect quoting indicates the variable quantity of a foreign currency required to purchase
and trade one unit of the domestic currency, and this type of quoting system is called
"quantity quoting" because it indicates the literal quantity or literal amount of foreign
currency required to purchase a single unit of the domestic currency. In other words, the
indirect quote system uses the home currency as the base currency (Mankiw, 2013).

2.1.2. Exchange Rate Systems

Based on the degree to which exchange rates are controlled by the government, exchange
rate systems can be classified. In general, exchange rate systems can be classified into one
of the following categories (Mankiw, 2013):

2.1.2.1. Fixed Exchange Rate

In a system with a fixed exchange rate, the exchange rate is either kept at a constant level or
is only allowed to fluctuate within a very narrow range. Governments intervene to keep an
exchange rate within these limits when it begins to move too much. In some cases, a
government depreciates its currency; in other cases, the government appreciates its currency
against other currencies (Mankiw, 2013).

• Advantages: MNCs can do international trade without worries about future exchange
rates. There is also a reduction in the risk of doing business in that country.
• Disadvantages: The value of the currency may be manipulated by the government.
In addition, a system of fixed exchange rates can make each country more vulnerable
to the economic conditions in other countries.

2.1.2.2. Floating Exchange Rate

The variable interest rate systems can be further divided into 2 sub-categories (Mankiw,
2013):

a. Freely floating exchange rate regime: Also known as clean floating. Exchange rate values
are determined by market forces without government intervention in a floating exchange
rate system.

• Advantages: Isolating a country from the inflation or unemployment problems of

other countries is a major advantage of this system. An additional advantage of this
system is that there is no need for a central bank to keep the exchange rate within
certain limits at all times.
• Disadvantages: Freely floating ER can sometimes exacerbate a country's economic
problems. Under such a system, multinationals would have to devote considerable
resources to the measurement and management of exposure to fluctuations in the
exchange rate.

b. Managed float: This is also known as a dirty float. In that exchange rates are allowed to
fluctuate on a daily basis and there are no official limits, it is similar to a floating exchange
rate system. Governments can and sometimes do intervene to prevent their currencies from
falling too far, similar to a fixed exchange rate system.

• Advantage: There is no risk of a crash in the value of the currency if there is a crash.
• Disadvantage: Some criticize such a policy as protection of the home currency at
the expense of other currencies.
2.1.2.3. Pegged Exchange Rate
The value of the domestic currency is pegged to a foreign currency in such a system. The
pegged currency moves according to the currency to which it is pegged against other
currencies. Some currencies, like the Argentine peso or Chinese yuan, are pegged to a single
currency (the US dollar), while others are pegged to a currency composite, like the European
currency composite (Mankiw, 2013).

- Advantage: A pegged system benefits both countries by virtually eliminating

exchange rate risk when a country conducts most of its trade with another country.
- Disadvantage: The risk of devaluation of the currency to which it is pegged. (In
summary: Madura, 402-407).

2.1.2.4. The Impossible Trinity

It's worth mentioning the theory of the impossible trinity when discussing a country's
preference for one of the exchange rate systems (Mankiw, 2013).

Figure 1: The Impossible Trinity. N. Gregory Mankiw, Macroeconomics textbook

The analysis of exchange rate regimes leads to a single conclusion: no authority can have all
three regimes at the same time, as the figure above suggests. In economics, this concept is
called the impossible trinity, also called the macroeconomic trilemma.
The impossible trinity concept argues that it's not feasible for a nation to have all three
regimes simultaneously. In other words, it's not feasible for a country to have free capital
movements, a pegged exchange rate, and an independent monetary policy.

Therefore, a country should have a preference for one of the edges of the triangle shown,
while at the same time renouncing the opposite corner (Mankiw, 2013).

The first preference allows free capital movement and independent monetary policy, as the
US did, but it's not feasible to have a pegged regime in this condition; instead, the exchange
rate should fluctuate to balance the currency market. The next preference, as in the case of
Hong Kong, is to accept the free movement of capital and the pegging of the exchange rate.
In this case, the country loses an independent monetary policy. Or it would not be able to.
The third option, which China has recently adopted, is to restrict the international movement
of capital. In this respect, interest rates will be determined by domestic forces (Mankiw,
2013).

It will previously be influenced by world interest rates, similar to a closed economy. The
exchange rate can be pegged and an independent or autonomous monetary policy can be
pursued (Mankiw, 2013).

2.1.3. APPROACH TO EXCHANGE RATES

According to this view, write-offs are expansionary for growing the economy. This is
commonly known as the traditional view. This view is that currency depreciation will make
local goods cheaper abroad and there will be an increase in demand for these goods and an
increase in exports (Salvatore, 2005).

The view that devaluation has an expansionary effect on output is evidenced by the fact that
devaluing the currency improves the balance of trade, alleviates balance of payments
difficulties, and accordingly expands output and employment (Acar, 2000).

An argument for devaluation is that devaluing your currency makes your exports more cost
competitive. The conventional view of the relationship between the FX rate and economic
growth holds that the FX rate affects economic growth through two main channels. The
following analyzes these two
2.3.1. THE TOTAL FACTOR PRODUCTIVITY GROWTH CHANNEL
The total factor productivity growth channel holds that a currency depreciation will shift the
composition of a country's output away from the production of non-traded goods and toward
the production of traded goods. The link from output composition to growth is through
economy-wide productivity gains generated by the production of some types of traded
products (exported manufactured products) through mechanisms such as technology and
skill transmission related to learning by doing that is external to the firm (Montiel et al.,
2008).

This shift to producing traded goods and improving technology increases investment locally,
exports, and ultimately economic growth. The total factor productivity growth channel puts
domestic production structure at the center of analysis (Eichengreen, B, 2008).

The profitability of the tradable sector improves when the real exchange rate depreciates,
which is equivalent to an increase in the price of tradables relative to non-tradables. Overall
productivity in the economy rises as production shifts from the non-tradable sector to the
tradable sector, which is characterized by a higher (social marginal) level of productivity.
Such an improvement in productivity across the economy ultimately promotes growth
(Mbaye, 2012).

Acar (2000) explains that a depreciation of the exchange rate shifts demand away from
imported and towards domestic products, raising the relative prices of imported products.
On the other hand, the export industry becomes more competitive in the international market
by stimulating the domestic production of tradable goods and inducing the domestic industry
to use more domestic inputs (Acar, 2000).

Norris et al. (2005) argue that exchange rate changes affect aggregate demand by improving
international competitiveness and by increasing net exports. In other words, the economic
performance of the manufacturing sector improves when the rand depreciates against other
currencies, as local people opt for domestic goods. Simultaneously, the country exports more
and imports less, creating favorable net exports. Ngandu et al. (2006) further explain that an
increase in exports is expected to lead to an increase in aggregate demand and ultimately to
an increase in domestic output and employment through the multiplier effect (Ngandu et al.
, 2006).
Since devaluation tends to be inflationary, it is argued that the increase in the general price
level leads to a reduction in the real wage, which in turn leads to more hiring and an increase
in output, assuming there is unemployment in the economy.

The TFP growth channel is criticized for failing to specify how it works, apart from
assuming that it is learning by doing. It also lacks empirical support; for example, (Mbaye,
2012) argues that there is no empirical investigation of the effect of the undervaluation of
the real exchange rate on growth under the TFP transmission channel. The second channel
under the traditional approach, and one that has become more common among policymakers,
links real exchange rate depreciation with growth via effects on the domestic saving rate
(Montiel et al., 2008)Under this channel, a depreciation of the real exchange rate increases
the domestic saving rate, which in turn stimulates growth through an increase in the rate of
capital formation. The following discusses this channel.

2.3.2. CAPITAL ACCUMULATION GROWTH CHANNEL

According to this approach, exchange rates affect economic growth through the effect they
have on saving. This approach argues that an undervaluation of the real exchange rate boosts
growth by increasing the capital stock of the entire economy. This view is based on the
assumption that a depreciated real exchange rate will tend to increase domestic saving. By
increasing the rate of capital accumulation, the higher saving rate induced by the
depreciation stimulates growth (Mbaye, 2012).

According to (Montiel et al., 2008), although consensus does not exist on precise channels
of transmission, an increasingly common view among policymakers’ points to saving as an
important channel of transmission, arguing that depreciation of real exchange rates increases
domestic saving rates, thereby stimulating growth by increasing capital accumulation.

There are two sources of capital accumulation in the capital accumulation channel. Mbaye
(2012) explains that under former mechanism, capital accumulation takes place exclusively
in traded goods sector, which is increasing its share in GDP, whereas under latter
mechanism, capital stock in economy is increasing due to expansion of aggregate saving and
investing (Mbaye, 2012).

The relationship between the depreciation of real exchange rates and savings rates arises
from the fact that the depreciation of real exchange rates tends to shift aggregate demand
away from tradables and towards no tradables, which necessitates the raising of real interest
rates to maintain internal equilibrium. By raising the domestic saving rate, the increase in
interest rates also constrains aggregate demand. From this perspective, causality runs from
real exchange rate to real interest rate to saving rate, which increases economic growth
(Montiel et al., 2008).

Dooley, et al. (2004) have argued that high savings rates in many Asian countries, including
China, are at least partly due to pursuing these exchange rate policies as part of their export-
oriented strategy. It is important to note that there are two conceptual links in the causal
chain underlying the capital formation channel of exchange rates.

First, from the real exchange rate to saving, and second, from saving to growth. The second
link, from savings to economic growth, is well known. It has long been an underpinning of
the mainstream growth process. However, there is both theoretical and empirical debate
about the first link between exchange rates and savings. (Montiel et al., 2008) also argue
that, if real exchange rates are the policy objective, improving the current account through
depreciation will increase national saving relative to investment. Through another channel,
a more depreciated real exchange rate can also lead to higher saving (Montiel et al., 2008).

For example, a more depreciated real exchange rate will have the effect of lowering the real
wage level of firms. Lower wages, in turn, lower the cost of production and induce firms to
increase investment. Consequently, firms increase their saving to finance their additional
investment, which ultimately raises aggregate saving. The validity of the capital
accumulation channel is debated. For example, Bernanke (2005) argues that the causality
runs from a high savings rate to a depreciated exchange rate, not the other way around. The
rationale is as follows: A high savings rate tends to depress domestic demand. Countries
maintain a depreciated real exchange rate to maintain internal equilibrium. If this view is
right, the empirical correlation between exchange rates and saving does not imply the capital
accumulation channel (Montiel et al., 2008).

Even if the causality is in the right direction, from exchange rates to savers, the second
linkage from savers to growth may fail to materialize because the same high real interest
rate that leads to a higher domestic savers' rate would also tend to crowd out domestic
investment. The existence of a link between the real exchange rate and the savings rate, as
well as the interpretation of this link if it exists, is questionable, according to (Montiel et al.,
2008).

Especially for less economically developed countries that rely heavily on imported capital
goods and infrastructure, the traditional approach poses a challenge. Depreciating the
currency makes exports cheaper for foreign buyers, but imports become more expensive for
local buyers. Local firms that rely on imported capital goods will pass on the additional costs
to their customers in the form of higher prices, which will lead to inflation. The formulation
of the structuralist approach to exchange rates partly failed to address this challenge (Montiel
et al., 2008).

Acar (2000) explains that by the end of the 1970s, there was a break in the consensus on the
view that devaluation was a source of output expansion. The possibility that devaluation
could be contractionary, especially in developing countries, gave rise to an alternative
approach. This line of approach is referred to as the structuralist approach (Acar, 2000).

2.1.4. Exchange Rate AND INFLATION

A large number of studies that have been carried out at different scales and in different areas
of study have been conducted to assess the link between the exchange rate and inflation and
their joint impact on the other key macroeconomic variables.

Kataranova (2010), in studying the relationship between exchange rate and inflation in
Russia, applied the Granger causality test and the distributed lag model technique. The
author found that the exchange rate had a negative effect on inflation in the country using
monthly data from 2000 to 2008 (Kataranova, 2010).

One-way causality from exchange rate to inflation was identified. In addition to that, their
study found out that as a result of the pass-through, consumer prices react immediately to
the depreciation of the national currency than to the appreciation of the national currency,
and that's definitely true in the case of food prices. As a recommendation to the policy
makers, they've suggested that regular decrease in general prices or inflation can only be
achieved by a combination of macroeconomic kind policies of controlled fiscal and
monetary policies.

Ahmad et al. (1999) conducted similar research using Pakistan as a case study; they
examined the causal relationship between inflation and exchange rate in Pakistan. To assess
the causal relationship between the above variables, the authors applied Granger causality
technique on quarterly data from 1982 to 1996. They confirmed a bi-directional relationship
between the two variables in the short and long run, inflation is the Granger cause of
exchange rates and exchange rates are the Granger cause of inflation. They also pointed out
that the speed with which prices adjust and the exchange rate reacts to local or even external
impulses is slow; policies aimed at fighting inflation or anti-inflationary policies would not
have their effects immediately, but rather gradually (Ahmad et al., 2019).

Asari et al (2011) used various econometrics techniques (Vector Error Correction Model,
Cointegration Test, Granger Causality Test, and Impulse Response Functions) to examine
relationship between exchange rate and other selected variables (including inflation) in
Malaysia from 1999 to 2009.They concluded that exchange rate shock has negative long run
effect on Malaysia's inflation (Asari et al. , 2011).

Odusola et al (2001) examined the relationship between naira depreciation through official
exchange rate, output and inflation using quarterly data series from 1970.1 to 1995.4 from
Nigeria using vector autoregression (VAR) and impulse response function technique
(Odusola et al. , 2001).

Their findings revealed that there is a long run relationship (co-integration) among the
variables under study. In other words, the impulse response functions that measure the
impact of shocks and the variance decomposition revealed that the exchange rate
depreciation has an expansionary effect on output in both the medium and long run. While
in the short run, the opposite was observed. This indicates that there was a contractionary
impact.

To examine the empirical link between inflation and exchange rate, (Madesha et al. , 2013)
applied Johansen cointegration technique and Granger causality approach to time series data
between 1980 and 2007. Their study found a long-run association between the variables and
bidirectional causality.

Imimole et al. (2011) used the ARDL model technique to identify the long-run and short-
run interactions among money supply, exchange rate depreciation, and gross domestic
product using a data set from Nigeria spanning from 1986 to 2008. They found that the
depreciation had a beneficial effect on inflation in Nigeria (Imimole et al., 2011).

Udoh et al. (2008) conducted a study using a yearly data set from 1970 to 2005. They
evaluated the impact of exchange rate shocks on inflation and foreign direct investment.
Exchange rate volatility and inflation uncertainty have significant negative impact on FDI
according to their findings (Udoh et al. , 2010).

Adetiloye (2010) used the causal approach to identify the causal relationship between CPI
and official and parallel exchange rates in Nigeria. Their report was that there is a cord of
causal relationship. The parallel exchange rate influences the official exchange rate, which
then pulls on the rates, while both the parallel and official exchange rates influence the CPI
(Adetiloye et al., 2010).

Abdurehman et al. (2016) attempted to assess the relationship between the exchange rates
of the British pound, the Turkish lira, and inflation in Turkey. In order to evaluate the nexus
between inflation and exchange rate, the researchers applied OLS method and GARCH
model. The results of OLS method showed that: Purchasing Power Parity (PPP) does not
hold for Turkey (Abdurehman et al., 2016).

However, ARCH and GARCH effects were found to be present, which means that deviations
from the PPT are not random or coincidental and follow a certain pattern (pattern
(Bayraktutan et al., 2003) used cointegration and causality tests to examine the relationship
between exchange rate and other selected variables (including inflation) in Turkey from
1980 to 2000. Their results showed a long-run relationship between the variables; however,
no causal relationship was found in either direction.

Using monthly series from 1984.1 to 2003.12, Gül et al. (2006) examined the relationship
between inflation and the nominal exchange rate in Turkey. Their results showed the
existence of a cointegration relationship between inflation and the exchange rate. They also
found a unidirectional causality from the exchange rate to inflation. To assess the
relationship between exchange rate and inflation uncertainty, Albuquerque and Portugal
(2005) used more sophisticated generalized autoregressive conditional GARCH models. A
semi-concave relationship between inflation shocks and exchange rates was found (Gül et
al. , 2006).

Bailliu et al. (2005) examine whether the pass-through of exchange rate movements to final
consumer prices decreases significantly after a shift to a lower inflation environment
stimulated by a change in the monetary policy stance. In order to differ from the existing
literature, the researchers used a panel data approach consisting of 11 industrialized
countries covering the period from 1977 to 2007. Their result holds the assumption that the
exchange rate pass-through takes a rain check by a change to a lower inflation environment
passed through a change in the monetary policy regime. Consequently, the results also
suggest that after the strategies designed to stabilize inflation in many developed countries
in the early 1990s, the pass-through to producers, imports, and consumer prices decreased
(Bailliu et al., 2011).
Asad et al. (2012) studied the relationship between the exchange rates and many other
macroeconomic factors such as the real income, the money supply, the inflation, the speed
of the circulation of income, and the real effective exchange rates in Pakistan. The period
covered by the researcher is 1970 to 2007 and the results concluded that the effect of
exchange rate on inflation in Pakistan is not significant; i.e., from the conclusion of the
correlation matrix, a strong positive relationship between the exchange rates and inflation is
discovered (Asad et al., 2012).

The study of (Stone et al. , 2009) on the occasional papers of the IMF has examined the
political and operational position of the exchange rate within the broader monetary
framework of inflation targeting in the developing countries. Their analyses, using a small
model tailored to inflation-targeting economies, involved case studies and extensive
documentation of exchange rate performance in different countries. Among the notable
findings are the following First, an open but limited role for the exchange rate is well
supported by the model-based analyses. Second, depending on how the economy is
structured, the gains from a more explicit policy stance for the exchange rate are different.
The policy rule takes into account the shocks to which it is exposed (Stone et al. , 2009).

2.2. THE IMPACT OF THE EXCHANGE RATE ON THE ECONOMIC

GROWTH IN DIFFERNTS COUNTRIES
There are mixed results from a review of the literature on the impact of exchange rate
volatility on economic growth. The impact of exchange rate volatility on growth is mixed.
Significant negative effects on growth have been found in several studies. Positive effects
of exchange rate volatility on growth have been found in other studies.

The relationship between exchange rate volatility and growth in emerging Europe and East
Asia is analyzed by (Schnabl, 2008). They specify an unbalanced cross-country panel model
for 17 emerging European countries and 9 East Asian countries to identify the effect of
exchange rate volatility on growth (Schnabl, 2008).

The estimation results provide evidence of a negative relationship between exchange rate
volatility and growth for Emerging Europe with respect to exchange rate volatility against
the euro. The specification for the full sample with all the control variables suggests that the
volatility of the exchange rate against the euro has a significant negative impact on the
growth rate.
To analyze the impact of exchange rate volatility on the growth performance of domestic
versus foreign and listed versus unlisted private manufacturing firms in Turkey, Demir
(2013) uses a firm-level dataset. The empirical results suggest that exchange rate volatility
has a significant growth-reducing effect on manufacturing firms, using dynamic panel data
estimation techniques. However, it is found that having access to both foreign and domestic
stock markets can reduce these negative effects at a significant level (Demir, 2013)

Using quarterly data for the period 1998-2014, (Yıldız et al., 2016) use the Engle-Granger
cointegration approach to investigate the relationship between economic growth and
exchange rate volatility in Turkey. They find that there is a short-run and long-run
relationship between economic growth and real effective exchange rate. In contrast, some
studies find a positive relationship between exchange rate volatility and growth (Yıldız et
al., 2016).

Using quarterly data from 1982 to 2001, Kasman et al. (2005) examines the effect of real
exchange rate volatility on Turkey's exports to its major trading partners. They find that
exchange rate volatility has a significant positive long-run effect on exporting volumes. This
result may be an indication that firms in a small economy like Turkey have few options for
dealing with increased exchange rate risk.

Adeniyi et al. (2019) examine the impact of exchange rate volatility on economic growth in
Nigeria through the use of ARDL model. The findings revealed that there exists
cointegration among the variables. The results also showed that export has a significant
impact on gross domestic product. However, import is insignificant in both the short and
long run. The study found that there is insignificant positive relationship between exchange
rate volatility and economic growth in Nigeria (Adeniyi et al. , 2019).

Whereas (Sabina et al., 2017) found negative relationship between exchange rate volatility
and economic growth in Nigeria. They use Generalized Method of Moments (GMM) in the
estimation of the effect of volatility and economic growth in Nigeria. The result shows that
volatility and foreign direct investment have negative and significant effect on the growth
of the Nigerian economy.

For the period under study, government expenditure and external reserve have positive and
significant impact on the growth of the Nigerian economy. The study recommends that the
government and the monetary authorities should design policies that will stabilize the
persistent volatility of the exchange rate of the naira (Sabina et al., 2017).
Using time series data from 1971 to 2012, (Odili, 2015) uses a vector error correction model
to analyze the impact of real exchange rate volatility and economic growth on Nigeria's
exports and imports. The study finds that exchange rate volatility, real exchange rate, real
foreign income, real gross domestic product, terms of trade and exchange rate policy change
are the main determinants of Nigeria's trade flows in both the short and long run. Findings
further revealed that exchange rate volatility depressed long-run trade flows (Odili, 2015).

Ahiabor et al. (2019) examine the effect of real effective exchange rate volatility on
economic growth in Ghana using Fully Modified Ordinary Least Squares (FMOLS) and
annual time series data from 1980-2015. The results of the regressions indicate that the
volatility of the real effective exchange rate has a negative and highly statistically significant
effect on the economic growth in Ghana. They also estimate models with traditional control
variables as well as a novel measure of financial market fragility. The results are still
consistent (Ahiabor et al. , 2019).

Using an ARDL model, (Hussain et al. , 2009). study the relationship between economic
growth and exchange rate volatility in Pakistan. Except for exports and imports,
cointegration relationship is found between growth, exchange rate volatility, reserve money
and output in the long run. The conclusion suggests that the performance of the domestic
economy is highly sensitive to the volatility of the exchange rate in the long run (Hussain
et al. , 2009).

The effect of exchange rate volatility on economic growth in English speaking countries in
West Africa was examined by Umaru et al. (2018). The results obtained show that the
independent variable (real exchange rate) has a statistically significant and negative
relationship with the dependent variable (GDP) in West African English-speaking countries
with the exception of time invariant variables (Umaru et al., 2018).

Musyoki et al. (2012) used Generalized Method Moments (GMM) to assess the impact of
real exchange rate volatility on economic growth in Kenya between January 1993 and
December 2009. Throughout the study period, the study found that the RER was highly
volatile. Kenya's RER generally exhibited a trend of appreciation and volatility. This implies
that the country's international competitiveness deteriorated during the study period. The
volatility of RER reflected a negative impact on Kenya's economic growth (Musyoki et al.
, 2012).
2.3. THE IMPACT OF THE EXCHANGE RATE ON THE ECONOMIC
GROWTH IN TURKEY
The relationship between the level of the exchange rate and economic growth has been the
subject of much empirical research. A strong causal relationship between the level of the
exchange rate and economic growth has been documented in most of this empirical research.

Indeed, the direction of causality from the exchange rate to economic growth seems to be
widely accepted. Whether this causality from the exchange rate to economic growth is
positive or negative, however, is a matter of disagreement.

Whether the effects of the exchange rate on economic growth are positive or negative has
been the subject of considerable debate. Generally speaking, the conventional view argues
that the increase in exchange rate has a positive effect on economic growth, while the
structuralist view argues that the increase in exchange rate causes the contraction of the
economy.

In the conventional view, an increase in the exchange rate has a positive effect on economic
growth through an increase in the volume of net exports. Here, the change in the relative
prices of domestic and foreign goods after the exchange rate appreciation is the main reason
for the increase in the output level with the expansion of net exports. A depreciation of local
currency lowers prices of domestic goods and simultaneously raises prices of foreign goods
significantly.

Therefore, a depreciation of the exchange rate first increases the volume of net exports and
then increases the rate of economic growth. The implication is that devaluation can be used
as a policy tool for the promotion of economic growth.

Indeed, many econometric results have emerged in the mainstream studies regarding the
positive correlation between appreciating exchange rate and net export or economic growth.
Accordingly, the literature has widely documented the positive impact of currency
devaluation on economic growth.

Domaç (1997) examined the relationship between the exchange rate and economic growth
in Turkey for the period from 1960 to 1990. He found that unanticipated devaluations had a
positive effect on output using regression analysis. As a result, the author found that the
hypothesis of a contractionary devaluation is not valid in Turkey (Domaç, 1997).
For Fiji's economy between 1970 and 2000, (Narayan et al. , 2007) examined the effects of
devaluation. They used the cointegration method. They found that the devaluation led to an
expansionary effect on the output level in the short and long run. More specifically, there
was a 3.3% increase in output for a 10% devaluation.

Tarawalie (2010) used the Johansen cointegration technique for the period 19990Q1-
2006Q4 to provide empirical estimates of the relationship between the real exchange rate
and economic growth in Sierra Leone. The results indicated that the real exchange rate was
found to affect economic growth. Specifically, output growth in Sierra Leone increased
when the real exchange rate depreciated.

The relationship between exchange rate and economic growth in Italy was analyzed by Di
Nino et al. (2011). Using a data set covering the period 1861-2011, they concluded that there
is a positive relationship between undervaluation and economic growth. In addition, the
authors also showed that undervaluation supported growth through an increase in exports,
particularly in sectors with high levels of productivity.

The role of the exchange rate in economic growth and the convergence of growth rates across
Chinese provinces was the focus of (Chen, 2012). He used a dynamic panel data estimation
method. He used data from 1992 to 2008 for 28 provinces. His findings were that the
appreciation of the real exchange rate had a positive effect on the provincial economies.

By using three stage least square approaches, (Aman et al., 2013) examined the link between
the exchange rate and economic development in Pakistan during the years 1976–2010. They
demonstrated that by encouraging export and import replacement industries, the exchange
rate has a favorable effect on economic growth.

The effect of currency rates on Nigeria's economic development from 1970 to 2010 was
analyzed by (Obansa et al. , 2013). The findings showed that the exchange rate significantly
influenced economic growth in the favor. They discovered data to support the idea that real
exchange rate depreciation and economic growth are strongly correlated. There are several
research that demonstrate a favorable relationship between the exchange rate and economic
development when multi-country studies are included.

Using data from 188 nations between 1950 and 2004, (Rodrik et al., 2008) investigated the
connection between economic growth and real exchange rates. Rodrik discovered a
consistent correlation between actual exchange rate appreciation and depreciation. Yet, the
increase in the real exchange rate's depreciation only resulted in economic expansion in a
few emerging nations. He contends that developed; wealthy countries' economy is not
affected by this link.

Using a large sample of 63 developing countries from 1978 to 2007, (Missio et al., 2015)
conducted an empirical analysis of the link between real exchange rate and production
growth rate. They discovered that keeping the actual exchange rate competitive has a
favorable impact on growth rate. This finding indicates that currency depreciation can
impact an economy's long-term growth by increasing the income elasticity of the demand
for exports.

In the post-Bretton Woods era, (Habib et al. , 2017) used five-year average data for a panel
of over 150 countries to assess the effects of changes in the real exchange rate on economic
development. They found that a real depreciation increased the real GDP growth per year.
The findings therefore demonstrated the wider impacts of devaluation on economic
development for emerging nations. As can be seen from the literature cited above, several
research have demonstrated that a rising exchange rate benefits the economy, supporting the
devaluation strategy for increased economic growth (Habib et al. , 2017).

Economic development is constrained by the growing exchange rate, according to

structuralist economists, particularly in emerging nations. Devaluation strategy therefore has
a restraint effect on emerging nations' growth (Bird et al. , 2004).

Exchange rate hikes have a detrimental effect on economic growth because they have a
restricting influence on the imported inputs that are a major component of the production
structure in emerging nations. Hence, by reducing imports of investment products,
intermediate goods, and raw materials, exchange rate hikes have a negative effect on
economic growth. Because of this, some industrialized nations benefit from the devaluation
strategy while emerging ones suffer detrimental effects on their economies' growth
(Hallwood et al., 2003).

Also, it has been claimed that imports slow down economic progress in underdeveloped
nations by bringing in novel ideas and technologies. Hence, imports have an impact on
economic growth in emerging nations by boosting local technological capabilities in
addition to supplying production input. The distribution of new technology across nations
creates the routes from imported machinery and intermediary items.
Hence, it is obvious that imports have an effect on the progress of emerging nations through
enhancing the technological capability of the economy through the transfer of new
information. The significant contribution of imports to the spread of technology has been
well established in the literature (Keller, 2004).

So, diverse conclusions concerning the connection between the exchange rate and economic
growth are reached by structural economists based on distinct views they have established
on emerging nations. To such an extent that the increasing exchange rate, which results in
limited imports in emerging nations, lowers economic development by limiting both
production input and knowledge transfer.
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