Exchange Rate and Trade Balance Relationship: The Experience of ASEAN Countries

Abstract

This study addresses the question of whether exchange rate changes have any significant and direct impact on trade balance. By examining the trade balances between ASEAN-5 countries and Japan for the sample period from 1986 to 1999, this study found that the role of exchange rate changes in initiating changes in the trade balances has been exaggerated. As such, an alternative explanation to the observed behaviour of ASEAN-5 trade balances in the selected sample period has been postulated. In particular, we propose that trade balance is affected by real money, rather than nominal exchange rate. A mathematical framework that provides theoretical background to our proposition is presented. Our empirical data analysis suggests that the real money effect proposition could consistently explain the observed trade balances in Malaysia, Singapore, Thailand and the Philippines during the period of study, with respect to Japan. Thus, in order to cope with trade deficits, the governments of these ASEAN countries might resort to policy measures focusing on the variable of real money.Exchange rate; Trade balance; Real money; Purchasing power parity; ASEAN-5 Economies.