An aggregate import demand function for Australia: a cointegration approach

Abstract

This paper investigates the relationship among quantity of imports, relative import prices and real GDP in the aggregate import demand function for Australia during the period 1959Q3Ã’2006Q3. Testing for cointegration, we find these variables are not stationary but are cointegrated. The results are consistent across three different cointegration tests conducted, namely the Engle-GrangerÃŒs residual-based test, the Johansen and Juselius multivariate test and the Bounds Test. As only one cointegration vector is found, there is a unique long-run equilibrium relationship among the variables. In the long-run, the price elasticity is found to be close to unity and import demand is found to be fairly income elastic. The error correction model is used to investigate the dynamic behaviour of import demand. In the short-run, Australian import demand is both price and income inelastic. Price is more elastic than income in the short-run, indicating that it is the dominant determinant of Australian import demand in the short-run. Furthermore, the estimated error correction coefficient of 0.3090 suggests that the aggregated Australian import demand corrects from the previous periodÃŒs disequilibrium by 31% per quarter. That is, it takes approximately 10 months to fully realign any disequilibrium that occurs. This study provides the only assessment of Australian import demand including a precise estimate for the short-run relationship, especially an estimate of the short-run adjustment term. This information will provide further input to support policy decisions relating to the management of the Australian trade balance.Import demand, Cointegration, Error correction model Acknowledgements: The first author would like to acknowledge financial assistance from the School of Accounting, Finance and Economics at Edith Cowan University, Western Australia.