The Effect of Exchange Rate Movements on Trade Balance: A Chronological Theoretical Review

Dhakir Abbas Ali,Mohammad Haji Alias,Fuadah Johari

doi:10.1155/2014/893170

Dhakir Abbas Ali, Mohammad Haji Alias + Show 1 more

Open Access

https://doi.org/10.1155/2014/893170

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Abstract

This paper evaluates the current state of the literature concerning the effects of exchange rate movements on trade balance. Thus, this paper is a review article and provides a survey of the alternative theories that focus on the effect of exchange rate changes on the trade balance. It systemizes the literature into four distinct reviews and approaches following the chronological order. The paper presents the (a) Standard Theory of International Trade, (b) Elasticity Approach, (c) Keynesian Absorption Approach, and (d) Monetary Approach. The study shows that higher attention should be given for the most plausible dynamic theory in this field, known as the J-Curve.

Highlights

As one of the widely used economic indicators, real exchange rate can be defined as the nominal exchange rate that takes inflation differentials among countries into account [1]
Real exchange rate movements affect many economic variables; where some studies covered the relation with foreign direct investment [3], some other studies focused on the effect on tourism [4] or, even more generally, on economic growth [5]
This study systemized the theoretical literature on the effect of exchange rate movements on trade balance into four approaches, namely, (a) Standard Theory of International Trade, (b) Elasticity Approach, (c) Keynesian Absorption Approach, and (d) Monetary Approach

Summary

Introduction

As one of the widely used economic indicators, real exchange rate can be defined as the nominal exchange rate that takes inflation differentials among countries into account [1]. Its importance stems from the fact that it reflects the trade competitiveness [2] It is still widely used in many fields of economics for purposes other than trade. A change in real exchange rate leads to variations in short-run capital flows. As a result, these fluctuations would have an effect on the Central Bank’s net foreign assets [6]. This study is concerned with its effects on international trade. This study investigates the state of the literature from a new perspective. It systemizes the explanations provided in empirical studies into distinctive theoretical approaches.

The Impact of Exchange Rate Movements on Trade Balance

Research Method

The Determinants Effect of Exchange Rate on Trade Balance

Concluding Remarks