Trade balance equilibrium, exchange rate volatility and optimality of exchange rate regime choice: An empirical investigation of emerging countries

Résumé

Abstract

The real effective exchange rate holds significant importance as a crucial gauge of a nation's global competitiveness in the economy, thereby exerting a potent influence on the development of its foreign trade activities. In an imperfect economic system where instability is the rule and stability is the exception, exchange rate volatility can harm countries' trade balances, especially in emerging countries with less-developed financial markets. Against this backdrop, our article attempts to provide some answers to the problem of choosing the optimal exchange rate regime to mitigate the effect of exchange rate volatility on the trade balance of emerging countries. Our research used a dataset encompassing 13 emerging nations from 1990 to 2020. We point out that real effective exchange rate volatility was assessed using the GARCH (1.1) model. In contrast, the CS-ARDL model was employed to measure the degree of impact of exchange rate volatility on emerging countries' trade balances under each type of exchange rate regime adopted to ultimately deduce the optimal exchange rate regime for these countries. Our empirical findings substantiate the presence of a penalising effect of exchange rate volatility on the trade balance of our sample countries, which tends to disappear as we move from fixed to flexible and floating exchange rate regimes. We can therefore conclude that flexible exchange rate regimes, due to their stabilizing function, are the most advantageous in mitigating the effects of exchange rate volatility on emerging countries's trade balances.

Keywords: Trade balance ; Exchange rate regimes; Exchange rate volatility ; Emerging countries ; Panel data ; GARCH model; Panel CS-ARDL model.