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Trade Balance and Exchange Rate: Unit Roots, Co‐integration and Long Memory in the US and the UK

Author

Listed:
  • Luis A. Gil‐Alana
  • Natalia Luqui
  • Juncal Cunado

Abstract

This paper deals with the relationship between the balance of trade and the exchange rate in the US/UK case. Many authors have studied this issue for many countries, but despite the intensive research, there is still no agreement about the effectiveness of currency devaluation to increase a country's balance of trade. We first analyse the relationship between the two variables using unit roots and co‐integration methods, and the results are ambiguous. We try a new approach based on fractional integration. The unit root hypothesis is rejected in case of the trade balance in favour of smaller orders of integration, while this hypothesis is not rejected for the exchange rate. Thus, the two series do not possess the same order of integration. We sort this problem out by taking the exchange rate as an exogenous variable, and including it in a regression model where the residuals might follow a fractionally integrated model.

Suggested Citation

  • Luis A. Gil‐Alana & Natalia Luqui & Juncal Cunado, 2008. "Trade Balance and Exchange Rate: Unit Roots, Co‐integration and Long Memory in the US and the UK," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 37(1), pages 59-74, February.
    • Handle: RePEc:bla:ecnote:v:37:y:2008:i:1:p:59-74
    DOI: 10.1111/j.1468-0300.2008.00192.x
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    References listed on IDEAS

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    Cited by:

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    3. Juan Carlos Cuestas, 2019. "Quantile regressions, asymmetric adjustment and crisis: the case of EU real exchange rates," Working Papers 2019/09, Economics Department, Universitat Jaume I, Castellón (Spain).

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