Munich Personal RePEc Archive

Does currency depreciation necessarily result in positive trade balance ? new evidence from Norway

Dzanan, Haris and Masih, Mansur (2017): Does currency depreciation necessarily result in positive trade balance ? new evidence from Norway.

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Abstract

The aim of this study is to investigate how exchange rate affects the trade balance in developed countries such as Norway, by using Time Series Multivariate Forecasting techniques to test the correlation in the long run. Theoretically, low exchange rates have positive impact on trade balance. However, it is only possible when the sum of the elasticity of demand for export commodities and demand for import goods is greater than unity. Accordingly, this study found no empirical evidence for the effect of exchange rate on trade balance in the long run. This is perhaps due to the fact that exports did not respond as expected. Norway products are mostly petroleum goods. It is known that petroleum goods have low price elasticity of demand; as prices become lower (or home currency depreciates compared to foreign currencies) foreigners will buy a constant amount of the petroleum goods. It also means, however, that if there is an increase in price (home currency appreciates compared to foreign currencies), demand for petroleum products will remain the same. The research is unique in the sense that no previous studies have been done on this issue for Norway. It also discusses the policy implications from the results of this study, stressing that policymakers should not be more concerned with external instability of the country through exchange rate as compared to the other variables such as inflation or perhaps lending interest rate.

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