Exchange Rate Policy And Trade Balance Of Developing Economy

The purpose of this study is to estimate the impact of exchange rate on balance of trade of developing countries, particularly, Bangladesh. This paper employed state-of-the-art cointegration techniques and the error correction mechanism to explore the linkage between trade balance, and real exchange rate in both short- and long-run. Estimated results demonstrate that the real exchange rate has a significant positive influence on Bangladeshi trade balance. Granger Causality test suggests that there are both way causal relations between balance of trade and real exchange rate. The study also examined whether the Marshall−Lerner condition holds in Bangladeshi data by using the Impulse Response Function which suggests that the J-curve idea is appropriate in response to exchange rate devaluation of Bangladesh. A panel study also has been employed to examine whether the devaluation can generate competitiveness of Bangladeshi exports in the world market. Estimated result reveals that relatively lower price of Bangladeshi export goods and service through devaluation can generate competitiveness.