The Trade Balance and the Real Exchange Rate: Evidence from a VAR for the United States

Abstract

Although the exchange rate is a traditional theoretical detenninant of the trade balance, there is little recent empirical evidence that supports its importance. Recent influential research has dismissed any relationship between these two variables. This paper uses a lOl~country index of the dollar in a VAR model and reinstates the role of the exchange rate in explaining the aggregate trade balance of the United States. The major finding is that a broad measure of the exchange rate that accounts for a full set of trading partners of the United States influences the trade balance in the medium term. (FlO, F41)