Real exchange rate effects on the balance of trade: cointegration and the Marshall–Lerner condition

Abstract

A typical finding in the empirical literature is that import and export demand elasticities are rather low, and that the Marshall-Lerner (ML) condition does not hold. However, despite the evidence against the ML condition, the consensus is that real devaluations do improve the balance of trade, though after a lag because of J-curve effects. The aim of this paper is to try and measure the effects of the real exchange rate on the balance of payments using structural cointegrating vector autoregressive distributed lag (VARDL) models for domestic and foreign output, the balance of trade and the real exchange rate. Small systems are estimated for eight OECD countries to investigate long-run cointegration. Generalized impulse response functions are calculated to investigate the response to shocks. These show evidence of J-effects. The VARDL estimates suggest a single cointegrating vector and that output and the real exchange rate can be treated as weakly exogenous for the parameters of the balance of payment equation. This allows estimation using a single-equation ARDL. Although there is considerable heterogeneity, overall the results suggest that the ML condition is satisfied in the long run.

Exchange Rate and Balance of Payment: An Autoregressive Distributed Lag (Ardl) Econometric Investigation on Nigeria

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“…Johnston and Chinn (1996) find evidence of a long run relationship between trade flows, incomes and the real exchange rate over the 1973-93 period. Boyd et al (2001) examine the behavior of the trade ratio (the log of real exports divide by real imports) over the 1970-94 period and find evidence of cointegration, although the specification they use constrains the import and export elasticities to be equal and opposite in sign.…”

Incomes, Exchange Rates and the US Trade Deficit, Once Again*

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