Do exchange rate changes improve the trade balance: An asymmetric nonlinear cointegration approach

Abstract

This paper examines the impact of real effective exchange rate on the trade balance of eight countries in the context of several nonlinear techniques, especially the nonlinear auto-regressive distributed lag model (NARDL). The advantages of the NARDL approach vis-à-vis earlier approaches is that it provides more efficient short-run and long-run coefficient estimates and allows through the distributed lag and the long-run dynamics a single common cointegrating vector. Both parts are allowed to be asymmetric. While previous studies have relied on models that ignored the time series properties of the variable and some have used the linear ARDL and obtained mixed results, the current paper uses the nonlinear auto-regressive distributed lag model (NARDL). We show that this is due to the assumption that the relationship is symmetric in nature. Results from long-run cointegration analysis, short-run analysis and half-lives, all provide evidence indicating that when depreciation is separated from appreciation, it is shown to have significant effects on the trade balance but in an asymmetric model.