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Real Exchange Rate and Trade Balance in Pakistan: An ARDL Co-integration Approach

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  • Shah, Anwar
  • Majeed, Muhammad Tariq

Abstract

The paper aims to find the long run and the short run relationships between trade balance, income, money supply, and real effective exchange rate for the period 1980 to 2011 in the case of Pakistan. The analysis is based on bounds testing approach to co-integration and error correction models, developed within an autoregressive distributed lag (ARDL) framework. The results of the bounds test indicate a stable long-run relationship between the trade balance, income, money supply, and real effective exchange rate variables. The estimated results show that increase in the level of income and depreciation in the real effective exchange rate are negatively associated with trade balance in the long and short run. Our results show that the money supply determines the behaviour of the trade balance in the long run but not in the short run. We also use innovation accounting by simulating variance decompositions (VDC) and impulse response functions (IRF) for additional inferences and find long-run relationship between trade balance and real effective exchange rate and income variables. However, we do not find long-run relationship between trade balance and money supply (M2). Our findings also suggest that Marshal-Lerner Condition for trade balance does not hold.

Suggested Citation

  • Shah, Anwar & Majeed, Muhammad Tariq, 2014. "Real Exchange Rate and Trade Balance in Pakistan: An ARDL Co-integration Approach," MPRA Paper 57674, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:57674
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    References listed on IDEAS

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    Cited by:

    1. Dao, Kieu Oanh & Nguyen, V.C. & Dinh, Si Tri Nhan, 2020. "Real Effective Exchange Rate, Broad Money Supply, and Trade Balance in Vietnam: An Empirical Analysis from Bounds Test to a Cointegration Approach," OSF Preprints ze89s, Center for Open Science.
    2. Muhammad Shahid Hassan & Ayesha Wajid & Rukhsana Kalim, 2017. "Factors affecting trade deficit in Pakistan, India and Bangladesh," Economia Politica: Journal of Analytical and Institutional Economics, Springer;Fondazione Edison, vol. 34(2), pages 283-304, August.
    3. Hafsa Hina, 2020. "Correction of Trade Deficit through Depreciation - A Misdirected Policy: An Empirical Evidence from Pakistan," PIDE-Working Papers 2020:24, Pakistan Institute of Development Economics.
    4. Mubasher Iqbal & Rukshana Kalim & Noman Arshed, 2019. "Domestic and Foreign Incomes and Trade Balance - A Case of South Asian Economies," Asian Development Policy Review, Asian Economic and Social Society, vol. 7(4), pages 355-368, December.
    5. Arshad Ullah Jadoon & Yangda Guang, 2019. "The Effect Of Exchange Rate Fluctuations On Trade Balance Of Pakistan," International Journal of Economic Sciences, International Institute of Social and Economic Sciences, vol. 8(1), pages 68-80, June.
    6. Hafsa Hina, 2021. "What Do We Know of Trade Elasticities?," PIDE Knowledge Brief 2021:30, Pakistan Institute of Development Economics.

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    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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