Examining the Relationship Between Trade Balance and Exchange Rate: the Case of China's Trade with the Usa
Introduction
This study addresses the question of whether exchange rate changes have any significant and direct impact on trade balance. By examining the trade balances between one of the Asians country which is china and US countries for the sample period from 1977 to 2008, this study found that the role of exchange rate changes in initiating changes in the trade balances has been exaggerated. As such, an alternative explanation to the observed behavior of China trade balances in the selected sample period has been postulated. In particular, we propose that trade balance is affected by real money, rather than nominal exchange rate. A mathematical framework that provides theoretical background to our proposition is presented. Our empirical data analysis suggests that the real money effect proposition could consistently explain the observed trade balances in China, Singapore, Thailand, malaysia and the Philippines during the period of study, with respect to Japan. Thus, in order to cope with trade deficits, the governments of china might resort to policy measures focusing on the variable of real money.
Theoretical Framework
Notionally, the predictable view of the stability of payments says that a small devaluation of currency improves trade balance. This vision is fixed in a static and limited equilibrium approach to the set of scales of payments that is well known as elasticity approach (Metzler, 1948). The view was the substitution impacts with in consumption and production induced by the relative price domestic versus foreign changes caused by devaluation. The model, which commonly known as BRM model, has been recognized in literature as providing a sufficient condition for an improvement of trade balance as exchange rates devalue.
The Marshall-Lerner condition states that for a positive outcome of devaluation on the trade balance, and unconditionally for a stable exchange market, the complete values of the sum of the demand elasticizes for exports and
This study addresses the question of whether exchange rate changes have any significant and direct impact on trade balance. By examining the trade balances between one of the Asians country which is china and US countries for the sample period from 1977 to 2008, this study found that the role of exchange rate changes in initiating changes in the trade balances has been exaggerated. As such, an alternative explanation to the observed behavior of China trade balances in the selected sample period has been postulated. In particular, we propose that trade balance is affected by real money, rather than nominal exchange rate. A mathematical framework that provides theoretical background to our proposition is presented. Our empirical data analysis suggests that the real money effect proposition could consistently explain the observed trade balances in China, Singapore, Thailand, malaysia and the Philippines during the period of study, with respect to Japan. Thus, in order to cope with trade deficits, the governments of china might resort to policy measures focusing on the variable of real money.
Theoretical Framework
Notionally, the predictable view of the stability of payments says that a small devaluation of currency improves trade balance. This vision is fixed in a static and limited equilibrium approach to the set of scales of payments that is well known as elasticity approach (Metzler, 1948). The view was the substitution impacts with in consumption and production induced by the relative price domestic versus foreign changes caused by devaluation. The model, which commonly known as BRM model, has been recognized in literature as providing a sufficient condition for an improvement of trade balance as exchange rates devalue.
The Marshall-Lerner condition states that for a positive outcome of devaluation on the trade balance, and unconditionally for a stable exchange market, the complete values of the sum of the demand elasticizes for exports and