Exchange Rates and the Trade Balance : Korea Experience 1970 to 1996

Abstract

The purpose of this paper is to examine the relationship between the real trade balance and the real exchange rate for bilateral trade in merchandise goods between Korea and both the USA and Japan on a quarterly basis over the period 1970 to 1996 using the partial reduced form model of Rose and Yellen (1989) derived from the two-country imperfect substitutes model. In line with recent work using a similar methodology, our findings suggest that when account is taken of the non-stationarity of the underlying data. the real exchange rate does not have a significant impact on the real bilateral trade balance with respect to the USA or Japan. Only when we ran the estimating equations in logs of levels using ordinary least squares did we find a significant relationship for Korean trade with the USA. supporting previous work by Han-Min Hsing and Savvides (1996). As far as the J-curve is concerned, we find no persuasive evidence of a J-curve effect at work. It is, however, possible that 'small country' effects are at work, whereby a tendency to price exports in foreign rather than domestic currency generates a rise in the domestic currency value of exports during the currency contract period which masks the initial rise in import values associated with J-curve behavior, but there was no evidence that imports subsequently fell as the lag length increased, which would be required to support a strict interpretation of the J-curve.