Applying the Vector Error Correction Model (VECM) to Measure the Impact of Changes in the Exchange Rate on Libyan Agricultural Imports During the period 1978-2022

Abstract

Like other rentier developing countries, Libya suffers from the impact of external shocks on the local economy. As a result, currency fluctuations occur, affecting the cost of imports in general and agricultural imports in particular. The study aims to measure the impact of changes in the Libyan dinar exchange rate on agricultural imports during the period extending from 1978 to 2022, The cointegration methodology and error correction model were used to achieve this goal. The results showed that the study variables were stable after taking the first difference according to the Dickey-Fuller and Phillips-Perron tests. It was also proven using the Granger causality test that there is a causal relationship in one direction from the exchange rate variable to the agricultural imports variable. Based on the Johanson test, it was found that there is a long-term equilibrium relationship between the two variables (co-integration relationship). Accordingly, the error correction model (VECM) was applied, which showed that the change in the exchange rate negatively affects agricultural imports in both the short and long term. From the error correction factor, it was found that the time required to correct the deviation in agricultural imports from the short term to the long term is 27 months. Using response analysis, it was found that any shock in the exchange rate will negatively affect the agricultural importer over the next six years. The most prominent recommendations included improving exchange rate management to avoid rising import costs and working to increase domestic agricultural production to reduce reliance on imports.