A test for structural change in U.S. real trade and trade prices: Fixed exchange rate period vs. flexible exchange rate period

Abstract

Critics of the flexible exchange rate system charge that exchange rate variability has a negative effect on international trade. In this study a simultaneous model of real trade, trade prices, and the exchange rate is consistently estimated with instrumental variables methods, using data on U.S. trade with nine major industrial countries. The real trade and trade price equations are tested for structural change between the fixed and flexible rate with a X2 test. The demand for U.S. real imports shifted significantly, and further tests indicate a significant negative effect during the flexible rate period. U.S. real exports and trade prices were stable throughout. The estimates of the model for the flexible rate period indicate that the exchange rate has a strong, lagged impact on trade, and vice versa. These strong, but slow, cross-effects result in long explosive cycles of dollar appreciation, worsening U.S. trade balance, and dollar depreciation.