How do you think the rise in oil price in recent times has impacted the effectiveness of devaluation in developing countries?
Well, as you may suspect the impact varies from one country to another. Your question implies that the developing countries' currencies were devalued on purpose; if that's true, such a case is exceptional. More likely the currencies have depreciated in recent times, and it is related to jump in oil price. Both of them are connected to the aspect -Quantitative Easing undertaken by US along with near ZIRP policy. QE process leads to massive release of new money into the system (in this case USD); over the last 5 years, the Fed has released trillions of dollars into the system, a lot of which found their way into the global economy via financial investments.
ZIRP meant low returns and QE meant new money, -this found its way into emerging/developing markets (EM) which pulled up the EM's currency. Since USD was also being devalued (via QE), measured in terms of commodity such as Oil, it has depreciated (i.e. there's a rise in oil price).
Given a country, if its oil import bill is significantly larger than its total quantum of exports -a depreciated currency would leave the country's BOP worse off. If however, the export industry is strong enough to offset rise in oil price the country may benefit. Either way depreciated currency + high oil prices mean that the developing country would need to earn more USD (since Oil is only traded in USD) which means the country has to *more* real resources in return for paper.
Thanks Prof. Abhijith for your contributions......so if we are to expect and quantify the points you have raised in your last paragraph, would it be important to treat oil price as an exogenous variable when trying to run econometrics to prove the theory...
Can anyone suggest me any empirical papers which has looked into how oil price might have impacted the effectiveness of devaluation in a import dependent economy and the rise in oil price might have limited the effectiveness of devaluation and been actually contractionary due to oil price rise.
I'm not sure if a multivariate analysis on a single (or a few) country would provide a definitive "proof"; assuming that's part of the analysis.. A meta-analysis of such movements drawn for secondary/empirical data sets would be more beneficial in providing a stronger perspective. In any case, oil price from a (non oil-rich) developing country is a exogenous variable.
If you would like a regional viewpoint you may try the paper "Oil Price, Energy Consumption and Macroeconomic Performance" available on SSRN network; it has certain gaps in analysis w.r.t exchange rate movements, but also has some useful pointers. It's a bit dated today, but P Krugman's paper "Oil and the Dollar" could provide a useful perspective to take your work ahead.
The fact of the matter is, currency devaluation makes people poorer. If a currency declines in value by 50%, and your wages do not rise by a corresponding 100%, then you are obviously getting paid less. However, it is usually not so apparent at first that this is the case. The way in which we get poorer is by rising prices such as those for gasoline, and a broad economic deterioration which is quite difficult to put your finger on exactly. It is obvious to anyone with their eyes open, though.
I think the link works through exchange rate pass through. In order to prove the relationship we may need index of inflation pertaining to imported commodities and services which is seldom available in developing countries. The oil price rise raises inflation through transportation channel.
Oil price movements should only affect the relative position of oil producers and oil consuming nations as a group. The U.S. has recently increased energy production via cracking so dramatically that it's hard to make clear historical comparisons. The U.S. is effectively switching groups.
But just look at the old situation for a moment, and assume the developing country is a net oil importer as the U.S. was a few years ago. Both economies would be slowed by rising energy costs, and would have to trade a larger fraction of their production for energy. This would temporarily create internal inflation but not necessarily affect the currency value relative to another net importer. However, the stimulus anticipated from devaluation, if any, would be derailed by hyperinflation. Since we did not see this, I'm inclined to agree with Abhijith that there was no intentional devaluation. (recent events in Japan do not qualify as Japan is not a developing country)
What we saw was that while oil demand was inelastic in the short run, in the long run people lost their jobs and could not buy oil, and the price dropped. Due to the previous high prices, investment was made in new production, accelerating the drop further, and there will be downward pressure on oil prices for many years. This is actually markets working.
Just now in another blog I made the point that the U.S. is still in deflationary mode. The Fed may be pumping money, but Congress is removing it, and productivity is increasing dramatically. The Fed's pump only barely offsets Congress and productivity increases. The rate of money supply increase must be permanently increased when productivity increases. I have quantitatively derived this in a paper I just uploaded https://www.researchgate.net/publication/258255561_Mechanism_for_extended_inversion_in_the_equity_premium?ev=prf_pub
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