Exchange Rate Changes And Trade Balance: An Empirical Study In The Case Of Japan

This paper attempts to identify the major economic factors that influence the bilateral trade balance of Japan with the US.Unlike elasticities approach,two additional macro variables are included to the VAR model estimation for trade balance using quarterly data from 1980:â… to 2006:â…£.Both parametric and semiparametric methods are applied.The results indicate a stable long-run relation among trade and four macro variables: domestic income,foreign income,net foreign assets and real interest rate. Short run adjustment parameters are also estimated as the coefficients of the error correction term.The variances in trade balance due to variation in the macro variables as well as the exchange rate change are examined by Impulse Response Functions and Variance Decomposition methods. The main finding of this paper is that taking the wealth effect and investment effect caused by exchange rate change into account,the final effect of exchange rate on trade balance is undetermined-appreciation is not certainly able to correct the trade balance surplus.