Does Currency Depreciation Certainly Result in Positive Trade Balance? Evidence from Pakistan

Abstract

The study attempts to examine the volatility of the exchange rate and the effect of depreciation of the domestic currency against the foreign currency on the trade balance of Pakistan. For that purpose, the time series data from 1976 to 2017 is extracted that is used to check the relation between exchange rate and trade balance. Moreover, this study applies Augmented Dickey Fuller (ADF) and Phillip Perron (PP) unit root tests to check the stationary element in the data. In order to find the cointegrated relationship among the selected variables an Autoregression Distributed Lag (ARDL) model is employed. Besides, the CUSUM test is executed to check the stability over time of the studied variables coefficients. The results of the unit root tests explain that the studied variables are integrated. Subsequently, the ARDL bound test specifies the long run association between trade balance and exchange rate. Finally, the CUSUM test confirms that all the studied variables are stable over the investigated time period. This study will be beneficial for the policy makers to make appropriate decision concerning trade balance of Pakistan and make better monetary policy.