Your browser does not support the PubReader view.
Go to this page to see a list of supporting browsers.
Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 25, No. 3, pp.317-337
ISSN: 1225-0279 (Print)
Print publication date 31 Aug 2012
Received 23 Mar 2012 Revised 12 Jul 2012 Accepted 13 Jul 2012

Dynamic Analysis of Trade Balance and Real Exchange Rate: A Stationary VAR Form of Error Correction Model Approach

Yun-Yeong Kim
Associate Professor, Department of International Trade, Dankook University, Jukjeon-Dong, Suji-Gu, Yongin 448-701, Korea, Tel: +82-31-8005-3402, Fax: +82-31-8021-7208 yunyeongkim@dankook.ac.kr

JEL Classification: F3

Abstract

This paper analyzes the dynamics of trade balance and real exchange rate based on the elasticity and purchasing power parity (PPP) approaches. Here, a stationary vector autoregressive model with cointegration error, transformed from the error correction model in Kim (2012), is employed. Trade balance and PPP are jointly considered as the two long-run cointegration relationships that represent external economy equilibria. The model was applied to the dynamic analyses of Korea’s trade balance using monthly data from 1990, where model variables from the elasticity and PPP approaches were selected. Based on the estimation, we first confirmed the finding of Cheung et al. (2004), whereas trade balance is additionally considered. The nominal exchange rate adjustment, not the price adjustment, is the key engine that governs the speed of PPP convergence, and the nominal exchange rates were found to converge much more slowly than the prices. The nominal exchange shock did not significantly affect trade balance, whereas the price shocks did. Therefore, manipulation of the nominal exchange rate through intervention to improve trade balance might not be an effective policy tool.

Keywords:

Trade balance, Real exchange rate, Error correction model, Stationary VAR

Acknowledgments

This work was supported by the research fund of Dankook University in 2012. The author would like to thank the co-editor and two anonymous referees for insightful comments and useful suggestions.

References

  • Campbell, J. Y., and Shiller, R. J. “Cointegration and Tests of Present Value Models.” Journal of Political Economy 95 (No. 5 1987): 1062-88. [https://doi.org/10.1086/261502]
  • Cheung, Y-W, Lai, K. S., and Bergman, M. “Dissecting the PPP Puzzle: the Unconventional Roles of Nominal Exchange Rate and Price Adjustments.” Journal of International Economics 64 (No. 1 2004): 135-50. [https://doi.org/10.1016/S0022-1996(03)00076-X]
  • Engel, C., and Morley, J. C. The Adjustment of Prices and the Adjustment of the Exchange Rate. NBER Working Papers No. 8550, National Bureau of Economic Research, 2001. [https://doi.org/10.3386/w8550]
  • Goldstein, M., and Khan, M. S. “Income and Price Effects in Foreign Trade.” In R. W. Jones and P. B. Kenen (eds.), Handbook of International Economics. Volume II, Amsterdam: North-Holland, pp. 979-1040, 1985.
  • Granger, C. W. J., and Swanson, N. R. “An Introduction to Stochastic Unit Root Processes.” Journal of Econometrics 80 (No. 1 1997): 35-62. [https://doi.org/10.1016/S0304-4076(96)00016-4]
  • Hansen, P. R. “Granger’s Representation Theorem: A Closed-Form Expression for I(1) Processes.” Econometrics Journal 8 (No. 1 2005): 23-38. [https://doi.org/10.1111/j.1368-423X.2005.00149.x]
  • Hsing, Y. “Effects of Crude Oil Prices and Macroeconomic Conditions on Output Growth in Mexico.” International Journal of Trade and Global Markets 1 (No. 4 2008): 409-18. [https://doi.org/10.1504/IJTGM.2008.021400]
  • Johansen, S. Likelihood-Based Inference in Cointegrated Vector Autoregressive Models. New York: Oxford University Press, 1995. [https://doi.org/10.1093/0198774508.001.0001]
  • Kim, J. Y. “Measuring the Length of Period for the Long-Run Equilibrium in a Cointegration Relation.” Seoul Journal of Economics 16 (No. 1 2003): 71-80.
  • Kim, Y-Y. “Stationary Vector Autoregressive Representation of Error Correction Models.” Theoretical Economics Letters 2 (No. 2 2012): 152-6. [https://doi.org/10.4236/tel.2012.22027]
  • Kim, Y-Y, and Park, Joon Y. “Testing Purchasing Power Parity in Transformed ECM with Nonstationary Disequilibrium Error.” Economic Papers 11 (No. 2 2008): 75-95.
  • Krugman, P. R., and Baldwin, R. E. “The Persistence of the U.S. Trade Deficit.” Brookings Papers on Economic Activity 18 (No. 1 1987): 1-56. [https://doi.org/10.2307/2534513]
  • Liu, P. “Purchasing Power Parity in Latin America: A Co-integration Analysis.” Weltwirtschaftliches Archiv 128 (No. 4 1992): 662-80. [https://doi.org/10.1007/BF02707298]
  • Lütkepohl, H. Introduction to Multiple Time Series Analysis. New York: Springer Verlag, 1991.
  • Moura, G., and Silva, S. D. “Is There a Brazilian J-Curve?” Economics Bulletin 6 (No. 10 2005): 1-17.
  • Pesaran, M. H., and Shin, Y. “Cointegration and Speed of Convergence to Equilibrium.” Journal of Econometrics 71 (No 1. 1996): 117-43. [https://doi.org/10.1016/0304-4076(94)01697-6]
  • Pesaran, M. H., and Shin, Y. “Generalized Impulse Response Analysis in Linear Multivariate Models.” Economic Letters 58 (No. 1 1998): 17-29. [https://doi.org/10.1016/S0165-1765(97)00214-0]
  • Rose, A., and Yellen, J. “Is There a J-Curve?” Journal of Monetary Economics 24 (No. 1 1989): 53-68. [https://doi.org/10.1016/0304-3932(89)90016-0]
  • Sims, C. A. “Macroeconomics and Reality.” Econometrica 48 (No. 1 1980): 1-48. [https://doi.org/10.2307/1912017]
  • Wu, J. L., and Chen, S. L. “Nominal Exchange-Rate Prediction: Evidence from a Nonlinear Approach.” Journal of International Money and Finance 20 (No. 4 2001): 521-32. [https://doi.org/10.1016/S0261-5606(01)00010-9]