Abstract
The objective of this paper is to shed new light on the nonlinear relationship between real exchange rate changes and trade balance in Cote d’Ivoire. In examining this issue, previous studies have relied on the nonlinear autoregressive distributed lag model developed by Shin et al. (2014) where real exchange rate is decomposed into partial sum of positive and negative changes. They fail to examine the response of the trade balance to extreme changes in the real exchange rate. In order to investigate possible sign and size-dependence in the response of the trade balance to exchange rate, this study uses multiple threshold nonlinear ARDL modeling. The approach is implemented using annual data covering the period 1975-2017. The results reveal that the effects of changes in real exchange rate are asymmetric in both time horizons. More specifically, real exchange rate appreciations deteriorate the trade balance while real depreciations improve it. Further, the effect of large depreciations is higher when compared with large appreciations.
Highlights
The relationship between the exchange rate and the trade balance is a subject of intense research in international economics, especially since 1973 when Magee (1973) introduced the concept of the J-curve effect
This paper re-examines the effect of the real exchange rate on the trade balance in Cote d’Ivoire
Previous studies on this issue relied on linear models in which real exchange rate depreciation and depreciation have the same effect, in absolute value, on the trade balance
Summary
The relationship between the exchange rate and the trade balance is a subject of intense research in international economics, especially since 1973 when Magee (1973) introduced the concept of the J-curve effect. According to this concept, a real devaluation of domestic currency leads to an initial deterioration of the trade balance, subsequently followed by an improvement. Devaluation improves the trade balance through two channels It makes the domestic goods cheaper for the foreign trading partners, increasing exports. Understanding the extent to which real exchange rate changes are passed through to trade balance is an important issue from balance payment perspective
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