U.S. BILATERAL NOMINAL TRADEBALANCE WITH INDIA, JAPAN, MALAYSIA, S. KOREA AND THAILAND, AND BILATERAL NOMINAL EXCHANGE RATE DYNAMICS: EVIDENCE ON J-CURVE?

This paper re-examines the effects of bilateral nominal exchange rate changes on U.S. bilateral nominal trade balances with India, Japan, Malaysia, South Korea and Thailand using monthly data from January 1985 through May 2005. The unit root tests, Johansen-Juselius cointegration procedure and the error-correction model are implemented. Each variable is nonstationary in level depicting I (1) behavior. Either λtrace or λmax test confirms cointegrating relationship between the above variables. There is evidence of long-run unidirectional causal flow from exchange rate changes to the changes in U.S. trade balance with each country with short-run interactive feedback relationships. Impulse response analysis exhibits no evidence to support the J-Curve hypothesis excepting Japan. INTRODUCTION This paper re-explores the dynamic causal relationships between the U.S. bilateral nominal trade balance with India, Japan, Malaysia, S. Korea and Thailand, and the bilateral nominal exchange rates using monthly data from January, 1985 through May, 2005. This issue is of increasing importance for the U.S.A. because, since 1981, its annual trade deficit has been consistently escalating (Krugman and Baldurin 1987). The recent fall of U.S. dollar against other major currencies during 2007 also sparks renewed interest in this topic. The U.S.A. pursues freer trade policy and in large measures allows its exchange rate to be determined by the market forces. Though a strong dollar is its declared policy, a weak dollar benefits it by promoting exports and reducing imports. However, these do not happen instantaneously. For example, the weak dollar provides protection to the ailing U.S. auto industry neutralizing the demand for trade restrictions and subsidy. Asia, in general, has been a major destination for U.S. exports. The above countries have been selected because of their strong and enhancing trade relationships with the U.S.A. These countries experienced robust economic growth throughout 1980s and 1990s excepting a brief period after 1997-98 Southeast Asian financial crisis. However, Japan was a notable exception because it went through a prolonged recession from 1988 until 2001. Currently, the U.S.A. has its largest trade deficit with China, but it was excluded from this study because it adopted a fixed exchange rate against the U.S. dollar until September 2005. Southwestern Economic Review 154 In theory, exchange rate depreciations would reduce imports and increase exports thereby reducing a country's trade deficit. But the effects of exchange rate depreciations on exports and imports are not instantaneous. In fact, they reveal lagged responses to exchange rate adjustments. Magee (1973) pioneered the J-curve theory to describe the effects of exchange rate depreciations on the trade balance. According to this theory, a country's trade deficit worsens just after its currency depreciates because price effects will dominate the effect on volume of imports in the short run. In other words, the higher cost of imports will more than offset the reduced volume of imports. Thus, the J-curve depicts that a decline in the value of U.S. dollar against another currency should be followed by a temporary worsening in the U.S. trade deficit before its longer-term improvement. The remainder of the paper is followed by a brief survey of the recent related literature, empirical methodology, analyses of results, and conclusions. BRIEF SURVEY OF SOME RECENT LITERATURE The vast and expanding empirical literature on the J-Curve hypothesis is anecdotal. But the evidences are mixed. This paper briefly surveys the relatively recent empirical literature on this topic. Rose and Yellen (1989) studied the short-run dynamics between exchange rate and trade balance. They found no evidence of the Jcurve for G-7 countries. Rose (1990) examined the relationship for a sample of developing countries and found no evidence of the J-curve. Wilson and Tat (2001) did not find any evidence of the J-curve for Singapore. Lal and Lowinger (2002) did not find any evidence of the J-curve for Japan. Bahmani-Oskooee and Ratha (2004) considered 18 major trading partners of the United States (Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Spain, Sweden, Switzerland and U.K.) and were unable to discover any J-curve pattern in the short run, although real depreciation of dollar revealed favorable effects on the U.S. trade balances in most cases. In contrast, Mahdavi and Sohrabian (1993) found evidence of a delayed Jcurve for the USA. Demirden and Pastine (1995) also found evidence of the J-curve for the USA. Kale (2001) found evidence of the J-curve for Turkey. Lal and Lowinger (2002) found evidence of the J-curve for a group of 7 East Asian countries (Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore and Thailand). Narayan (2004) concluded that New Zealand's trade balance exhibited a J-curve pattern following a depreciation of the New Zealand dollar. More recently, Rahman and Islam (2006) found weak evidence on the J-Curve hypothesis for Bangladesh using quarterly data from 1972 through 2003 with significant short-run deterioration in trade balance and a sluggish improvement in the long-run. EMPIRICAL METHODOLOGY In the context of the J-Curve, only two variables are involved in the estimating model as follows: