The Exchange Value of the Pakistan Rupee & Pakistan Trade Balance: An ARDL Bounds Testing Approach

Abstract

Results of previous studies on the correlation between exchange rate changes and trade balance are unpersuasive. The present endeavor tries to understand the direction of changes between trade balance and exchange rate and how the depreciation in exchange rate takes place by incorporating the absorption and monetary approaches including Marshal Lerner condition. Our results reveal that existence of long run relationship between exchange rate, income and money supply on trade balance examined through ARDL bounds testing approach. The lag of dependent variable i.e. trade balance has significant impact on the current year trade balance due to pervious year trade policy. At the same time, depreciation in exchange rate deteriorates the trade balance thus adoption of such trade policies that boost the trade balance in future are desirable. The results have also been indicated that beneficial impact of trade policies on trade balance is nullifying by the exchange rate depreciation. Low level of money supply rather than income plays an important role to improve the trade balance in Pakistan. The prevalence of Keynesian postulation exists in Pakistan that states 'income increase will encourage general public to purchase more imported goods and thus deteriorates the trade balance'. This paper would highlight some new insights for policy formulation regarding trade, exchange rate, and economic growth.