Abstract
This study examined the relationship between real exchange rate and terms of trade in Malaysia, Singapore, and Thailand in two cases, namely a three-variable case and a four-variable case. The results of cointegration tests showed that there is long-run relationships among real exchange rate, terms of trade, and relative demand for Malaysia. Moreover, there is long-run relationship among real exchange rate, terms of trade, relative demand, and relative real interest rate for Malaysia and Thailand. The results of Granger causality showed that real exchange rate does not Granger cause terms of trade, however the result is mixed for Thailand. The contribution of terms of trade and relative demand to real exchange rate is mixed and small. Generally, the contribution of terms of trade to real exchange rate is greater than the contribution of relative demand in Singapore. For Thailand, relative demand is more important than terms of trade in the determination of real exchange rate. For Malaysia, the results are mixed.
Highlights
It was argued that there is relationship between real exchange rate and terms of trade. Dungey (2004) used a latent factor model to examine the impact of terms of trade on real exchange rate volatility
For Malaysia, the contribution of terms of trade to real exchange rate is smaller than the contribution of relative demand over the horizon periods from 0 to 4, and the contribution of terms of trade to real exchange rate is greater than the contribution of relative demand over the horizon periods from 5 to 20
For Malaysia, the contribution of terms of trade to real exchange rate is smaller than the contribution of relative demand in the short-run but in the long-run, the contribution of terms of trade to real exchange rate is greater than the contribution of relative demand
Summary
It was argued that there is relationship between real exchange rate and terms of trade. Dungey (2004) used a latent factor model to examine the impact of terms of trade on real exchange rate volatility. It was argued that there is relationship between real exchange rate and terms of trade. Dungey (2004) used a latent factor model to examine the impact of terms of trade on real exchange rate volatility. The model is applied to an annual panel data of six Asian economies, namely Indonesia, Malaysia, Thailand, the Philippines, Pakistan, and Sri Lanka. The results showed that the contributions of terms of trade to real exchange rate volatility are higher in East Asian economies and almost negligible in Pakistan and Sri Lanka. The empirical evidence of the relationship between real exchange rate and terms of trade for developing and small open economies is limited, the empirical evidence of time series data. The empirical evidence of the relationship between real exchange rate and terms of trade is mixed (Dungey, 2004)
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