Abstract:
This study aims to examine the relationship between the exchange rate regime and economic
growth of Sri Lanka using annual time series data which covers the period from 1980 to 2017
empirically. ADF method has been used to check stationary. Vector Autoregressive model has
been used to select a lag length for the data. Johansen Cointegration test used to determine the
long-run relationship between variables. For the dynamic stability of long-run equilibrium Vector
Error Correction Model (VECM) has been used to find out whether the error term of long-run
equations has adjusted to converge towards long-run equilibrium and its speed of adjustment.
Results of this study demonstrate that all variables are non-stationary at the level, however,
becomes stationary at first difference. Vector Autoregressive model suggested one lag that has been
used throughout the econometric analysis. Johansen Cointegration results explain that there exists
a long-run relationship among variables under study. According to the long run VECM model,
results have identified that exchange rate and inflation are negatively related to economic growth
in Sri Lanka. Further, this study explains that there is a positive relationship between the exchange
rate regimes and economic growth of Sri Lanka in the long run. This study concluded that
independent floating regime has a positive impact on GDP of Sri Lanka than the managed floating
regime. Hence, this study suggests that Sri Lankan government want to control the government
intervention in determining the exchange rate, as well as they want to give the full freedom to the
market to determine the exchange rate
