Exchange rate volatility and bilateral agricultural trade flows: the case of the United States and OECD countries

Abstract

The abandonment of fixed exchange rate systems has caused exchange rate movements to become a major concern for traders, policy makers and researchers. During the previous four decades of floating exchange rates, numerous studies have been conducted to determine whether exchange rate volatility affected international trade flows. Researchers have not yet reached a general consensus as to the magnitude and direction of the impact of exchange rate volatility on trade flows. This study documents the effect of exchange rate volatility and real exchange rates on bilateral agricultural exports, imports and total trade flows between the United States and OECD countries. The effect of exchange rate volatility is estimated both separately from and in combination with the real exchange rate. In addition, implementation of Free Trade Agreements (FTAs) and use of the Euro as a national currency (Euro) are included as dummy variables and their effect on trade flows is determined. This study uses panel data, which contains 28 cross-sections and 1148 observations, for bilateral trade flows between the United States and OECD countries from 1970 to 2010. Data analysis is performed as guided by the gravity model which assumes trade flows to be directly proportional to economic mass and inversely proportional to geographical distance. Based on the gravity model, the ordinary least squares procedure is applied as the fixed effect one-way procedure for panel data. Effects of exchange rate volatility and the real exchange rate on agricultural, non-agricultural and total exports, imports and trade (exports +imports) flows were found to be statistically significant and negative. Although we were able to replicate the reportedly established notion that exchange rate volatility has an adverse effect on international trade flows, the negative effect that the real exchange rate has on trade flows is a novel finding and bears further investigation. It is found that exchange rate volatility has a greater impact on the agricultural sector, while the real exchange rate has a greater impact on the non-agricultural sector. Effects of FTAs and the Euro are always positive, with FTAs having a greater impact on the agricultural sector and the Euro on the non-agricultural sector.