The effects of exchange rate on the trade balance in Ghana: Evidence from co-integration analysis

Abstract

This paper examines the effects of exchange rates on the trade balance of Ghana. First, by deriving the real exchange rate as a function of preferences and technology of two trading economies and then by applying small price taking economy assumption to the Ghanaian economy, using annual time series data from 1970-2000 we estimate the trade balance as a function of the real exchange rate, domestic and foreign incomes. Co-integration analyses of both single equation models and VAR-Error correction models confirm a stable long run relationship between both exports and imports and the real exchange rate. The short-run elasticities of imports and exports indicate contractionary effects of devaluation, in terms of the Marshall-Lerner-Robinson conditions, though these elasticities add up to almost 1 in the long run estimates. The overall conclusion drawn from the study is that, for improved balance of trade in Ghana, coordination between the exchange rate and demand management policies should be strengthened and be based on the long run fundamentals of the economy. Key words: Exchange rate, trade policy, Ghana, co-integration.