Effect of Real Exchange Rate on Trade Balance: Commodity Level Evidence from Turkish Bilateral Trade Data1

Abstract

An initial currency depreciation/devaluation is expected to worsen the trade balance in short run, before leading to an improvement in the long run. Given the persistent nature of its current account deficits and large oscillations in Turkish Lira, prospective effects of exchange rate policy prescriptions raise academic interest in Turkish economy. This paper aims to investigate the links between the real exchange rate and the balance of trade. By employing cointegration technique and error correction modelling between Turkey and her major trading partner Germany, presence of J- Curve phenomenon is tested on a monthly basis over the period 2002 to 2014. We employed disaggregate data on commodity level. Use of disaggregated bilateral trade data avoids any aggregation bias. Furthermore, disaggregation at commodity level permits to weigh the effect of changes in real exchange rate on the individual industry trade balance. Empirical results provide some support for the existence of j-curve effect. Nevertheless, no single pattern of exchange rate - trade balance relationship is found to exist.