An Empirical Study on the Effects of Real Effective Exchange Rate on Algeria’s Trade Balance

Abstract

The purpose of this study is to estimate the effects of Real Effective Exchange Rate (REER) on Algeria’s trade balance (TB). There exist two groups of studies that have investigated in the short-run and long run effects of real effective exchange rate on trade balance. The first group has employed at aggregate level between Algeria and the rest of world. The second group has used the trade at the bilateral level between Algeria and her two major trading partners, US (as a largest export partner of Algeria) and France (as a largest import partner of Algeria). Since a country’s trade balance behavior is directly depending on real effective exchange rate (REER), foreign income (Y*) and real domestic income (Y), so, we include all these variables in our model to test the general case (Algeria-world case) and specific case (Algeria-France and Algeria-UScase). This study uses unit root tests, co-integration techniques, Error Correction Model (ECM) and impulse response function with time series data covering the periods of 1981Q1-2009Q4. The main findings of this study are: (i) REER have a significant expected impact (positive in long-run and negative in short-run) on the Algeria bilateral trade balance with respect to US and France, and on the total trade balance. (ii) The Granger Causality test suggests that REER does Granger causes trade balance for all cases of study. The study clearly demonstrates that real devaluations of exchange rate in Algeria have been positively associated with improvement of trade balance. Hence, devaluation of currency as a whole seems to be beneficial for Algeria exports.