Role of Exchange Rate on the UK-Germany Trade Balance: An Analysis at Industry Level
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The existing literature regarding the effect of exchange rate on trade balance shows the inconclusive empirical results. The current arguments for the mixed findings rest on the aggregation bias from aggregating of trading products and the exclusion of asymmetric effect in the analysis. This article examines the effect of exchange rate on the UK-Germany bilateral trade balance. The study is conducted at 2-digit level of 38 SITC industries, using monthly data during January 1999 to May 2017. The asymmetric effect is included by employing the nonlinear autoregressive distributed lag model (NARDL) in the estimations. The empirical findings confirm the existence of asymmetric effect. In the short run, a real depreciation of the British Pound (GBP) against Euro (EUR) improves the British trade balance in 17 industries, while a real appreciation of GBP deteriorates the trade balance in 10 industries. In the long run, the UK trade balance is improved from a real depreciation of GBP in 15 industries which constitute 38.12 per cent of the UK’s total trade share with Germany. On the other hand, it is aggravated by a real appreciation of GBP in 11 industries which hold 25.63 per cent of total trade. The J-curve effect is found in only 3 industries. The research findings indicate that exchange rate policy is still a valid tool to manage the Britain’s chronic trade deficit vis-à-vis Germany. The existence of asymmetric effect implies that the UK trade balance is affected by a depreciation rather than an appreciation of GBP.
Abstract
The existing literature regarding the effect of exchange rate on trade balance shows the inconclusive empirical results. The current arguments for the mixed findings rest on the aggregation bias from aggregating of trading products and the exclusion of asymmetric effect in the analysis. This article examines the effect of exchange rate on the UK-Germany bilateral trade balance. The study is conducted at 2-digit level of 38 SITC industries, using monthly data during January 1999 to May 2017. The asymmetric effect is included by employing the nonlinear autoregressive distributed lag model (NARDL) in the estimations. The empirical findings confirm the existence of asymmetric effect. In the short run, a real depreciation of the British Pound (GBP) against Euro (EUR) improves the British trade balance in 17 industries, while a real appreciation of GBP deteriorates the trade balance in 10 industries. In the long run, the UK trade balance is improved from a real depreciation of GBP in 15 industries which constitute 38.12 per cent of the UK’s total trade share with Germany. On the other hand, it is aggravated by a real appreciation of GBP in 11 industries which hold 25.63 per cent of total trade. The J-curve effect is found in only 3 industries. The research findings indicate that exchange rate policy is still a valid tool to manage the Britain’s chronic trade deficit vis-à-vis Germany. The existence of asymmetric effect implies that the UK trade balance is affected by a depreciation rather than an appreciation of GBP.
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