THE IMPACT OF REAL EXCHANGE RATE ON TRADE BALANCE

Abstract

The purpose of this study is to investigate the relationship between the trade balance
and the real exchange rate for bilateral trade in merchandise goods between Indonesia and the US, Japan and Singapore as its major trading partner. This article employs the
elasticity approach to analyze such a relationship. Johansen multivariate cointegration is
proposed to examine the impact of depreciation of real exchange rate on trade balance. To
tests for J-curve, a generalize impulse response function generated from a vector error-
correction model is applied.
Quarterly data over the period 1988:1-2003:4 are used for the analysis. Our findings
demonstrate that the real exchange rate has a positive impact on the bilateral trade
balance between Indonesia and Japan and Singapore. The generalized Marshall-Lerner
condition, however, seems to hold only for the bilateral trade balance between Indonesia
and Japan. This study also finds that there is an evidence for J-curve for Indonesia’s
bilateral trade balance with the Japan.

Keyword: real exchange rate, trade balance, Marshal-Lerner Condition and J-curve