The link between exchange rate uncertainty and Israeli exports to the US: 2SLS and cointegration approaches

Although the effect of uncertainty on economic behavior is of primary concern to both economists and policymakers, its theoretical and empirical treatment in the literature has led to inconclusive results. Indeed, the results of the various empirical studies are highly dependent on the statistical method employed and the proxy used for uncertainty. Using quarterly data for the period 1997-2010:1, this study examines the effect of exchange rate uncertainty on Israeli exports of goods to the US and finds support for the hypothesis that uncertainty has a negative and dominant effect on exports, in both the short run and the long run. Two important contributions are made to the empirical literature: the use of 2SLS in order to address the problem of simultaneity between the exchange rate and exports in this context and the testing of three uncertainty proxies. The use of Israeli data is also relevant to the empirical evidence for developed countries, since Israeli exports of goods to the US consist primarily of products with high value added in production. Contrary to theoretical claims in the literature, having a large proportion of high-value-added goods does not appear to significantly reduce the negative effect of uncertainty.