by 0.50 percent. The positive coefficient on y�� suggests that the higher the world income, the higher the exports.

The second long-run equilibrium relation describes a strong association between import, REER, and domestic income, and normalization is made on import: im� �0.59reer� �0.55y� �0.05t���� REER possesses a positive coefficient, which is to be expected as devaluation discourages imports. A 1 percent depreciation of the REER is associated with roughly 0.60 percent reduction in the imports of goods and services. A 1 percent increase in domestic income would increase imports by 0.55 percent. The adjustment coefficients show that only import equilibrium corrects to the long-run relation.

Altogether, the estimates show that the sum (in absolute value) of the export and import elasticities with respect to the real effective exchange rate exceeds unity. Therefore, the ML condition is met in the long run, suggesting that a real devaluation of the birr will considerably improve the balance of trade in Ethiopia. This finding is sufficiently robust against a wide array of sensitivity checks, such as using quarterly data for the subperiods 1992-2013 and 2004-13.

**Table 3. Identified Long-Run Structures**

||**Marshall**|**-Lerner co**<br>**Annua**<br>**(1980-**|**ndition**<br>**l data**<br>**2013)**|||**Expo **<br>**Qu**<br><br>**Manufac**|**rts By Se**<br>**arterly da**<br>**(2005-13)**<br>**turing**|**ctor**<br>**ta**<br>**Agric**|**ulture**|
|---|---|---|---|---|---|---|---|---|---|
|Var.|β<sup>�</sup>�|β<sup>�</sup>�|α��|α��|Var.|β<sup>�</sup>�|α��|β<sup>�</sup>�|α��|
|reer�|**0.50**<br>(2.83)|**-0.59**<br>(-3.45)|∗|∗|reer�|**1.06**<br>(2.04)|∗|**0.33**<br>(1.81)|∗|
|ex�|1.00|–|-1.11<br>(-4.27)||ex�<br>��|1.00|**-0.49**<br>(-2.36)|∗|∗|
|im�|–|1.00|0.52<br>(1.98)|-0.85<br>(-3.19)|ex�<br>����|–||1.00|**-2.04**<br>(11.10)|
|y�|–|-0.55<br>(-3.16)|∗|∗|y�<br>�|-4.59<br>(-2.28)|0.006<br>(2.31)|-1.21<br>(-2.19)|∗|
|y�<br>�|-6.36<br>(-5.42)|–|∗|∗|t|-0.06<br>(-5.80)|–|-0.03<br>(-9.97)||
|t����|-0.14<br>(-9.70)|-0.05<br>(-4.17)||||||||
|t|0.27<br>(6.11)|–||||||||

Note: _t_ -values in parentheses. The empirical models allow for a linear trend �t� to account for the trending nature of the variables and a broken linear trend in 1992 �t����� to capture the significant change in trend slopes (and thus the mean-shift �� ���� in growth rates) due to the political and economic regime change. ex� and ex� represent manufacturing and agricultural exports, respectively. *Denotes statistically insignificant error correction coefficients. Source: Haile (2015a,b).

# **The short-run impact of a devaluation on the trade balance**

Figure 14 plots the dynamic impulse response functions<sup>9</sup> for export and import as a result of a one standard error shock to the REER. The analysis finds that the contemporaneous impact of a one standard error positive shock to the REER (representing an appreciation) is a sharp decline in exports of about 0.04 percent and a surge in imports of approximately 0.07 percent. This implies a contemporaneous contraction in the trade balance of circa 0.11 percent. Conversely, a one standard error negative shock to REER, say via devaluation, would lead to a contemporaneous increase in the balance of trade of 0.11

> 9Impulse response analysis describes the knock-on effects on the system variables of a one standard error shock to a variable of interest, assuming that the system is not hit by other shocks thereafter.

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