Does Exchange-Rate Volatility Depress Export Flows: The Case of LDCs

By Arize, Augustine C.; Malindretos, John et al. | International Advances in Economic Research, February 2003 | Go to article overview

Does Exchange-Rate Volatility Depress Export Flows: The Case of LDCs


Arize, Augustine C., Malindretos, John, Kasibhatla, Krishna M., International Advances in Economic Research


Abstract

In the area of international trade, few studies have examined whether increases in exchange-rate volatility depress trade flows of LDCs. The aim of this paper is to investigate empirically the impact of exchange-rate volatility on the export flows of 10 developing countries over the quarterly period 1973-98. The econometric analysis exploits the theory of cointegration, given the obvious nonstationarity of the data. Estimates of the cointegrating relations are obtained using Johansen's multivariate procedure. Evidence of stability of the cointegrating space is examined using Hansen's [1992a] tests. Short-run dynamic modelling is accomplished using the error-correction technique, and the stability test results are obtained using Hansen [1992b] tests. In conformity with theoretical considerations, the results indicate that increases in the exchange-rate volatility exert a significant negative effect upon export demand in both the short-run and the long-run in most of the countries studied. These effects may res ult in significant reallocation of resources by market participants. (JEL F14, F31)

Introduction

There has been widespread concern among financial market participants, trade economists, the popular press, and policymakers over the high degree of volatility of most major exchange rates since the inception of floating rates in March 1973. Much of this concern stems from the adverse effects of increased uncertainty from high volatility in exchange rates on foreign trade. Such adverse effects from exchange-rate volatility on foreign trade have contributed to the abandonment of flexible exchange rates and to shifts toward systems of exchange rate management such as the European Monetary System and the West African Monetary Union. (1) Work by DeGrauwe [1988, p. 63] also notes that "the growth rate of international trade among industrial countries has declined by more than half since the inception of floating rates."

Studies by Rose [1999], Dell' Ariccia [1999], Chowdhury [1993], Cushman [1988], Thursby and Thursby [1987], and Kenen and Rodrik [1986], among others, have provided empirical evidence for developed countries, and most conclude in favor of the existence of a negative and statistically significant long-run equilibrium relationship between exchange-rate volatility and trade flows. For the less developed countries (LDCs), no similar conclusion has been reached because very few studies [Goes, 1981; Brada and Mendez, 1988; Caballero and Corbo, 1989; Arize et al., 2000] exist due to unavailability of sufficient time series data. Nevertheless, whether a high degree of exchange-rate variability has impact on foreign trade continues to be an important question in most LDCs since it has relevance in decisions concerning the choice of exchange-rate system as well as the conduct of exchange-rate policies.

The purpose of this paper is to investigate empirically the relationship between real exports and their determinants and to examine the constancy of this relationship. The focus is on 10 countries: Burkina Faso, Colombia, Costa Rica, Jordan, Kenya, Korea, Myanmar, Pakistan, South Africa, and Venezuela. Most of these countries have been excluded from previous studies and the sample is reasonably representative of developing countries. The results of this paper should be of interest to many readers because of the cross-country comparisons and because of the important role that exports play in today's economies--witness the discussion about the current Asian financial turmoil. The sample period is 1973:2-1998:1, and the null hypothesis being tested is that exchange-rate volatility has no statistically significant effect on export flows in the short-and long-run.

The paper has three objectives. The first is to determine empirically whether there exists a stationary long-run relationship among real exports, foreign economic activity, relative prices, and exchange-rate volatility. …

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