LITERETURE REVIEW: Relationship between exchange rate and Gross Domestic Product (GDP) in Pakistan Based on the previous research, GDP is one of the macroeconomic factors that able to influence the fluctuation of exchange rate. Therefore, there are many researchers are who have done this study in knowing the relationship between exchange rate and GDP in a countries including in Pakistan. So, a few studies have confirmed that exchange rate flexibility act positively on economic growth through its effect on the adjustment process to shocks (Mundell, 2011; Edwards & Yeyati, 2005; Barguellil, Ben-Salha, & Zmami, 2018). Friedman (1953) and Mundell (1961, 1963) studies that exchange rate regimes are regarded as main instrument in the analysis of economic efficiency. However, if floating exchange rate regimes occurs in the economy, it will lead to unpredictable volatility that affecting economic growth and financial market in Pakistan.
Nevertheless, there is a debate among the economists about the relationship between the exchange rate and the GDP. Zahoor Hussain (2009) assume that there exists positive relation between exchange rate volatility and economic growth in the long run. This positive relation could be led by monetary approach since the higher economic growth rates in a country will affect the value of the country’s currency and consequently will influence the exchange rate. Besides, there are also some studies that have proved the presence of negative effects of exchange rate volatility on some macroeconomic aggregates that may affect economic growth such as international trade, investment, and employment (Do?anlar, 2002; Servén, 2003; Demir, 2010; Belke ; Gros, 2001).
According to Akhtar and Hilton (1984), there is negative relationship between vitality of exchange rate and volume of foreign trade. Gotour (1985) studied that there is insignificant relationship between exchange rate and volume of trade but he also argue that there must be an indirect relationship. Based on then empirical studies, it also shows that fluctuations in exchange rates have adverse effects on exports, particularly in the long term.
According Kemal (2005) studies show that the exchange rate volatility is positively related with exports and negatively with imports in case of Pakistan. Hence, from this past research we assume that the exchange rate fluctuation will cause stagnant on the economic growth and slowing the economic growth. Based on the theory, there is a positive correlation between volatility of exchange rate and economy growth, which shows the devaluation or depreciation could raises the economic growth. Mujahid and Zeb (2014) shows that there are exist a two way relationship between devaluation and output growth, where there is expansionary effects of devaluation on output growth in the short run while in long run devaluation has contractionary effects on the economy of Pakistan (Datta, 2012).