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2015 Abstracts

The Relationship between Trade Balance, Income and Real Exchange Rate

Wonjin Kim, Weber State University


The trade balance of a country, calculated as total exports minus total imports, measures the impact of foreign trade on the demand for that country’s output. It is proposed that there are generally three key determinants of trade balance, e.g., the real exchange rate, home disposable income, and foreign disposable income. In principle, as the home country’s real exchange rate depreciates (rises), the country is expected to export more and import less. An increase in home country’s income is expected to increase imports and generate a decrease in home country’s trade balance. On the other hand, an increase in foreign income is expected to raise the home country’s trade balance. This paper makes an attempt to explore whether the expected relationships between trade balance, home income, foreign income and real exchange rate holds. The United States is considered the home country and Japan is considered the foreign country in this study. The reason for using Japan as a foreign country is twofold: first data availability and second, Japan is one of the largest trade partner of the United States. We use quarterly data to conduct our study. The sample period spans from 1994 to 2012. We hypothesize that the real exchange rate has a positive relationship with trade balance. Also, we hypothesize that the U.S. income has a negative and Japan’s income has a positive effect on the trade balance of the United States. To test our hypothesis we run a multiple regression. The dependent variable in our regression is trade balance. The independent variables are home and foreign incomes and real exchange rate.