Trade balances and exchange rates in the long run for European Union countries

Abstract

This paper has found evidence that real effective exchange rates have a positive impact on the trade balance in the long run for major European Union countries. This result sheds more light on the long-run statistical relationship between those two variables, at least in the context of the Community. The existence of that link is sustained by the effects that income variables have on the trade balance. The outcomes of this analysis in support of a long-run equilibrium relationship are consistent with the imperfect substitutes model, confirming the validity of this model for economic policy implementation purposes. Low, long-run elasticities of the trade balance with respect to the real effective exchange rate indicate that a substantial change in relative prices should be made to considerably improve trade accounts. This fact may be related to the prevailing tendencies of intraindustry trade among industrialized countries. Therefore, variables other than price should be stressed. Costs of relinquishing individual exchange rates in the monetary union may be, generally, rather moderate given the estimates of the price elasticities obtained. In any case, adjustment to external shocks will always be a real adjustment since one of the Maastricht commitments for European Union countries to reach monetary union in 1999 is the stability of exchange rates, abandoning them as instruments of economic policy. (JEL F10)