Relationship between exchange rate and trade balance in Norway

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Relationship between exchange rate and trade balance in Norway

1.1 Background of Norway economic system

Norway is a modern Europe state with officially name is Kingdom of Norway. Harmonizing to the World Bank, Norway Gross Domestic Product for twelvemonth 2010 ( estimation ) is deserving $ 433.304 million dollars, so Norwegians enjoy the 3rd largest GDP per capita in the universe. Norway is a state amply endowed with natural resources-petroleum and gas, hydropower, fish, forest and minerals. As a consequence, Norway economic is chiefly dependent on the crude oil sector, which accounts for about half of the exports and over 30 % of province gross.

Furthermore, Norway besides becomes the top five exporters in seafood, rough oil and transportation industries among the universe. The rich of resources in the states contribute the big gross to Norwegian. Norway is a less unfastened economic system and reported a trade balance excess which is 25.4 million NOK in June of 2010. A positive of trade balance indicate that Norway current history excess and exchange rate addition in the foreign exchange market.

1.2 History of Norwegian krone

Norse Monetary Union had been established on May 5, 1873. This pecuniary brotherhood was formed by Sweden and Denmark to repair their currencies and stability their exchange rates. Norway currency which is krone ( NOK ) was introduced in 1875 after Norway articulation this brotherhood. In making so, Norway krone have same degree with Sweden and Denmark which is 2.48 kroner/kronor per gm of gold.

Many states have remained their floating exchange rate after the prostration of Bretton Woods System in 1973. In this instance, Norway governments has stable the fix exchange rate on 1986 to 1992. However, this system has alteration during the period of agitation in European exchange market. As a consequence, the governments have allowed the Norse krone to drift on 10 December 1992. Furthermore, the alteration of Norway exchange rate becomes more fluctuation after 1996 when it was unstable of oil monetary value and crude oil in Norway. Subsequently, the alteration in monetary value of oil has influence the Norway future economic system development.

1.3 Exchange rate behaviour in Norway

Norway is the 3rd largest of oil and gas exporter in the universe after Saudi Arabia and Russia. The Norway currency alteration from one twelvemonth to another compared to other currencies. During the mid 1980, Norway bank were strongly regulated the fiscal system in both the measure of imparting money and involvement rate. However, when the oil monetary value started to worsen in 1985, many chief industries in Norway had been influenced and damaged. To get the better of this job, Norway pecuniary policy has increase the involvement rate to protect the kroner from devaluation. Besides that, pecuniary policy besides reduces the disposal income of family and command the size of import from foreign state. At the same clip, financial policy was implemented on December 1986 to repair the exchange rate. Furthermore, Norway economic system has strongly damage when the Asiatic currency crisis in 1997.Due to the monetary value of oil addition in 2001, Norse Kroner grew to the high degrees which is 8.99 NOK and against the US dollar and Euro. However, following by 2009, USD worth about 5.99 NOK. Here is the Norway exchange rate from twelvemonth 1980 to twelvemonth 2009.

Beginning: Federal Reserve System

1.4 The Concept of Exchange rate

Exchange rate can show as how much the state currency deserving regard to the foreign currency. In a somewhat difference position, exchange rate defined as a currency monetary value which can act upon by the demand and supply of the currencies involved. The exchange rate construct can formulated as:

E = D / F

Where: E=prevailing exchange rate in the foreign exchange market ;

F= foreign currency ;

D= domestic currency trade in foreign exchange market.

There are two types of exchange rate which are nominal exchange rate and existent exchange rate. Nominal exchange rate is the rate which the currency of a state is traded against for the currency of another. Central bank can repair and determinants the degree of the nominal exchange rate because the measure of money is printed by the cardinal bank.

Real exchange rate is the nominal exchange rate adjusted for comparative monetary value degrees. The existent exchange rate is the nominal rate multiplied by the ratio of the foreign to domestic monetary value degrees. However, to mensurate the degree of a state ‘s economic and measuring the impact of exchange rate on trade balance, existent exchange rate will be apply instead than nominal exchange rate.

1.4.1 Exchange rate Governments

There are two types of exchange governments, which are fix or flexible. Under a fixed exchange rate government, the authorities intervenes in the foreign exchange market in order to stabilise the exchange rate at fixed degree. When the rising prices in state is really high, authorities can nail down the exchange rate to stabilise the currency. In drifting exchange rate government, the nominal exchange rate is determined by the market. Under this government, exchange rate will simply alter over clip to set the rising prices rate. However, taking a best exchange rate government is depends on societal pick job by understand societal, economic, and policies of that state.

1.5 Determinant of exchange rate

In a free market, the equilibrium of exchange rate occurs at the point at which measure of demand equal the measure of supply of the foreign currency. The factors causes the supply and demand of exchange rate alteration is economic systems variables such as export, import, domestic and foreign income. Since the exchange rate under the natation system is determined by the market forces, market cardinal and market outlooks besides interact to act upon the exchange rate in both long tally and short tally.

Interest rate plays an of import function to act upon the motion of exchange rate. The addition in the involvement rate therefore causes the place currency appreciates in the short tally. When the place exchange rate is appreciates, occupants will buy more goods from abroad state because the foreign good is cheaper for them. As a consequence, the size of import will increase while the measure of export will diminish.

Another factor which is frequently mentioned in explicating the motion of exchange rate is rising prices rate. A high rising prices means the comparative monetary value degree was addition over a period, and this instance normally accompanied by the depreciation of exchange rate. As a general regulation, the lower rising prices rate will raise the currency value, therefore the buying power for occupants increase comparative to other foreign exchange rate.

The current history and the balance of payment is a term of trade to act upon the exchange rate. When the demand of export for foreign states is greater that import, the term of trade will go positive because current histories is excess. However, current histories shortage when the monetary value of exports raise smaller rate than import. As a consequence, the value of exchange rate lessening and demand for currency besides cut down.

Finally, the addition of money supply in a state will impact the exchange rate. A state with big public shortage and debt will attractive less foreign investor. To get the better of the debt duty, authorities will sell the bond in market to increase the money supply. In other words, the addition of money supply cause the higher rising prices exists in the economic system. Therefore, a big debt in state may act upon the exchange rate and decline the trade balance.

1.6 The Concept of Trade Balance

The trade balance, or sometimes called “ net export ” is a constituent of GDP when measured an economic growing. It is the relationship between state ‘s export and import of ware over a period of clip. In short, trade balance is export less import. A trade balance is known as trade excess when the export is more than import ; while the trade balance defined as trade shortage when import is more than export. There are three major factors influence the balance of trade, which are foreign exchange rate, domestic and foreign income and foreign monetary value degree.

Harmonizing to the Marshall Lerner status, when the exchange rate depreciation, the size of export in the state will increase more than import, therefore trade balance will better. On the other manus, when the exchange rate grasp, it will doing the trade shortage to lift because the import is more than export.

Besides that, the alteration in domestic and foreign income besides plays an of import factor to act upon the trade balance. If the Norway state income rises, the occupants will devour more foreign goods in abroad states. As a consequence, trade balance will shortage because the addition of Norway income cause the import addition. At the same clip, when the Norway income lessening, the demand for foreign goods will cut down, so this leads to merchandise excess.

Furthermore, an addition in monetary value degree in state besides will impact the trade balance. If Norway monetary value degree addition against foreign states, it will do the size of import addition more than export, therefore the trade shortage become worsen. In general, the falls of monetary value degree in state will do the foreign trade excess to lift.

1.7 Marshall Lerner Condition vs. J-curve

Marshall Lerner status explains the relationship between exchange rate and trade balance. When a state ‘s exchange rate devaluation relation to other states, this will better the balance of trade. At the same clip, export is increase because the monetary value of export is cheaper for foreign states. Besides that, Marshall Lerner status besides examines the monetary value of snap for export and import goods. If the demand snap for imports plus the demand snap for the export is exceeds one, so the Marshall Lerner status holds which the depreciation of exchange rate will better the trade balance.

However, Marshall Lerner status does non run into when the monetary value of goods tends to inelasticity. In the short tally, depreciation of exchange rate ab initio worsens the trade balance. But with the clip slowdown, the measure accommodation consequence becomes relevant, therefore the trade balance will better in the long term. This consequence is called J-curve forms. In decision, both Marshall Lerner status and J-curve are two construct that explain the consequence on trade balance when exchange rate depreciation or grasp.

1.8 Problem Statement

Exchange rates play an of import function in the economic growing. Today, many economic experts have been studied the relationship between exchange rate and trade balance both in short tally and long tally. Under the regulations of Breton Wood system, the exchange rate is fixed. However, after the prostration of the fix exchange rate in 1973, many states change their currency to the flexible exchange rate. Most surveies in the field of exchange rate have argued that big fluctuation of the exchange rate will impact the trade balance. Likewise, some surveies point out their consequence that the alteration of exchange rate is determine by the domestic income, foreign income and involvement rate. As a consequence, these variables have correlativity relationship with the trade balance.

Indeed, big fluctuation of exchange rate in the universe is a major issues concern by economic experts. Uncertainty in exchange rate could impair the smoothing of economic growing, which affects the trade and capital motions. Furthermore, when exporter and importer unable to get the better of the hazard they face, trade balance will ensue as shortage. This will follow by the negative effects in current history and balance of payment for developing states. Besides that, instability of exchange rate could do many issues and jobs happen in economic growing.

The variableness of currency affects the size of foreign exchange modesty. The state whose loss the value of currency is more worsen when exchanges the goods in foreign exchange market. Harmonizing to Marshall Lerner status, when currency devaluation against another foreign currency, it will better the economic trade balance. This status states that devaluation of exchange rate will do the monetary value of exports cheaper for foreign states, subsequently export public presentation will increase. At the same clip, demand for import will cut down because the foreign goods are expensive for the state citizens. On the other manus, the monetary value of import and export are determined by the monetary value of snap, so the J-curve phenomena will be.

Furthermore, another job that has happened under the natation of exchange rate is foreign debt duty. Since the motion of exchange rate can do the current history excess or shortage, it tends to impact the dealing of currencies in commercial bank. Central bank and other pecuniary policies are difficult to purchase and sell the foreign exchange because the alteration in exchange rate is unpredictability. This operation might besides do the cost of debt service addition. In short, fluctuation of exchange rate tends to deterioration the economic growing and international trade in one state.

Therefore, this paper tends to analyze Norway economic growing and the relationship between exchange rate and trade balance. Norway exchange rate alteration from one twelvemonth to another compared with foreign currencies. Since the Norway is the 3rd largest of gas and oil exporter in the universe, Norse kroner were fluctuating with the monetary value of oil, which may hold affected investor outlook in Norway future development economic system. So, one inquiry needs to be inquiring, nevertheless, whether the Norway trade balance determined by the fluctuation of exchange rate?

1.9 Research Objective

The general aim of this paper is to analyze the relationship between exchange rate and trade balance in Norway. Harmonizing to Marshall Lerner status, monetary value snap of demand for exports and imports must be greater than one. A depreciate of exchange rate will better economic growing, therefore it has positive relationship with trade balance. At the same clip, this paper will happen out whether the M-L status satisfied and grounds of J-curve forms exists in the Norway trade balance. More specific, this survey tends to place what factors determine the Norway exchange rate and trade balance in the long tally economic growing.

1.10 Significant of Study

Exchange rate is an of import variable for developing states in the foreign exchange market. After the Bretton Wood System breakdown in 1973, many developing states have moved their pegged exchange rate to the drifting exchange rate. This survey will concentrate the determiner of the exchange rate on trade balance in Norway. With the appropriate theoretical account, we can explicate the exchange rate behaviour in Norway and the impact of fluctuation exchange rate on economic system growing.

In general, the Ordinary Least Squares ( OLS ) theoretical account rarely applied by research workers to analyze the relationship between exchange rate and trade balance. Therefore, with available and latest information, this survey will utilize unit root trial and OLS theoretical account to proving the long tally relationship between these variable. Besides that, by utilizing clip series informations from 2000 to 2009 and other utile variables, this survey will show the empirical consequence whether there is a important correlativity exists among these variables.

Furthermore, the unstable of exchange rate has consequence the economic public presentation and international trade balance. So this survey will foreground the motion of exchange rate in order to keep the trade balance public presentation in Norway. More specific, this survey will let the research workers to recognize how much the impact size consequence on the economic system growing when the exchange rate devaluation or grasp.

Last, the part for this survey will heighten future research workers to compare and look into the exchange rate theoretical account for other developing states.

2.0 Introduction

Large fluctuation of exchange rate is a major issue faced by many developing states. This is because unsteadily of the exchange rate will impact the economic growing both in short tally and long tally. Many economic experts have been examined the relationship between exchange rate and trade balance in economic. Due to their empirical surveies, they found that J-curve pattern exist in the long tally where trade balance excess or shortage depends on the monetary values snap. In the short tally, devaluation ab initio worsens the trade balance, but so the trade balance start to increase in the long tally and higher than the initially volume. However, this consequence disagree by some economic experts, Rose and Yellen ( 1989 ) suggest that no grounds of J- curve response in America data.Their major determination showed that merely small relationship between US exchange rate and trade balance.

2.1 Literature Review

Yusof ( 2007 ) examined the relationship between existent exchange rate and trade balance both in short tally and long tally in Malaysia. They used co- integrating theoretical account and causality trial to bespeak whether the J-curve consequence got exists in the long tally. In this respects, they were covering the quarterly informations from 1997: 1 to 1998: 2. Their concluding consequences suggested that devaluation of exchange rate better the trade balance in the long tally. They besides examined that the J-curve form exists and consequence in the long tally. In the short tally, other variables such as domestic income and foreign income besides determined the trade balance.

Narayan ( 2004 ) used the Granger causality trial and co-integration trial to show the relationship between trade balance, exchange rate, domestic income and foreign income in New Zealand ‘s trade balance. However, the empirical consequence showed that there is no important relationship exists between trade balance, exchange rate and other variables. This consequence stated that these three variables are no co- integrating in the long tally. Besides that, he besides used impulse response analysis and found that J-curve behaviour exists in the New Zealand ‘s trade balance during the period 1970 to 2000.

Similarly, Narayan and Seema ( 2004 ) besides utilizing co-integration trial to surveies the Fijian economic system which covers the period from 1970 to 2002. The variables use for their survey is existent effectual exchange rate, domestic income and foreign income. By utilizing co-integration analysis, they found that there is a important relationship between trade balance and these variables. However, the empirical consequence from ADRL, DOLS, and FM-OLS theoretical account show that domestic income is the chief factor determine the Fijian trade balance and follow by the foreign income. Finally, they besides found that the grounds of J-curve hypothesis exist in the Fijian economic system.

Gomes and Paz ( 2005 ) surveies this instance for Brazil economic and utilizing the information from Jan 1990 to December 1998. In their surveies, they focus on the Marshall-Lerner status and the J-curve phenomenon to explicate the alteration in exchange rate on trade balance in Brazil economic system. Basically, they are used VEC-M theoretical account and VAR theoretical account to build the ML theoretical account. Their concluding consequence font that Brazil economic meet the ML status. In long tally, when Brazil exchanges rate devaluation, trade balance improves, therefore Brazil current history is excess and balance of payment is positive. However, the Brazil trade balance worsen when exchange rate devaluation in the short tally. This status made the J-curve behaviour nowadays in the Brazil.

Petrovic and Gligoric ( 2010 ) use granger causality trial to research whether exchange rate depreciation addition trade balance in Serbia or decline it. The times series informations for their research is from Jan 2002 until September 2007 which take monthly informations. Furthermore, the methodological analysis used in their paper is Johansen ‘s co-integration trial and Autoregressive Distribute Lag ( ADRL ) attack. From their findings, they conducted that existent exchange rate devaluation has a important relationship with the trade balance in Serbia. Besides that, they besides point out that there is a J-curve form exists in the Serbia trade balance.

However, some empirical surveies found that J-curve form does non necessary exists in all state and affect the trade balance. Unlike other states, China has no J-curve form both in the short tally and long tally. Brada et Al. ( 1993 ) used quarterly informations from 1980:1 to 1989:4 to turn to how China ‘s trade balance affected by the fluctuation of the existent exchange rate, domestic income and foreign income. They argued that with no J-curve consequence exists, devaluation of China ‘s existent exchange rate has improved balance of trade in economic system. By using a Johansen ‘s co-integration trial ; they provide strong grounds that there is a stable long tally relationship exists between exchange rate and trade balance.

Buluswar et Al. ( 1996 ) carried out that there is no co-integration relationship between trade balance and exchange rate in India during period 1960-1990. By utilizing the Johansen theoretical account, they points out that India authorities policies did n’t hold effectual pecuniary attack to command the trade shortage. Devaluation the exchange rate in the long tally important no affects the India trade balance. At the same clip, Granger trial conclusive the other variables such as money supply and monetary value index, including exchange rate no important relationship with the trade balance. Finally, this survey does non demo J-curve consequence in the India Trade balance.

Similarly, this consequence was support by Singh ( 2004 ) who besides surveies the J-curve hypothesis in India economic growing. By utilizing the GARCH theoretical account, the consequence showed that volatility of exchange rate does no important with the trade balance. However, the mistake rectification theoretical account carried out that existent exchange rate and domestic income plays a major function in determiners on India trade balance. This theoretical account is covering the quarterly informations from 1975:02 to 1996:03. His concluding consequence does non back up the issues of J-curve effects in India trade balance and there is no important relationship between exchange rate and trade balance.

Narayan ( 2004 ) old surveies point out that there have being the of J-curve form in New Zealand and Fiji. However, Narayan ( 2006 ) subsequently surveies argued that there is no grounds of J-curve behaviour in the China. This consequence were based upon monthly informations, cover the period from November 1976 to September 2002. The chief intent of his surveies is to look into the relationship between China ‘s trade balance and the existent exchange rate with the USA. Furthermore, Narayan ( 2006 ) applied impulse responses map to gauge the relationship between China balance of and exchange rate. Although his concluding consequence point out that Marshall Lerner status was hold but the J-curve affects does no trade with the instance in China.

Baharumshah ( 2001 ) carried out a similar consequence when he surveies the consequence of exchange rate on bilateral trade balance. In his major survey, Baharumshah ( 2001 ) utilizing the quarterly informations from 1980:1 to 1996:4. He attempts to place what factor determinants the trade balance of Malaysia and Thailand with US and Japan. By using the Johansen carbon monoxide integrating trial, he found that existent effectual exchange rate, domestic incomes and foreign incomes are of import variables to act upon the trade balance. Besides that, his paper has reported that devaluation of exchange rate improves the trade balance, but no grounds of J-curve form to suit the information. Wilson and Kua ( 2001 ) besides study the bilateral trade for US and Singapore. The present of partial decreased signifier theoretical account resulted that the existent exchange rate does non act upon the bilateral trade balance. They covering the quarterly informations from 1970 to 1996 and found that merely small grounds of J-curve phenomena exists when the exchange rate devaluation.

Furthermore, Baharumshah and Yol ( 2007 ) study the fluctuation of exchange rate on the bilateral trade balance between 10 African states and US over period 1997 to 2002. They use Johansen carbon monoxide integrating analysis that the trade balance is co integrated with the existent exchange rate. Besides that, the Marshall Lerner status does non fulfill in all 10 states because the snap of exchange rate is less than 1. The most of import determination shows that all 10 African states trade balance has important determiner by the fluctuation of exchange rate.

Most surveies in the field of exchange rate resulted that Marshall Lerner status was hold when the place currency devaluation. Brahmasrene ( 2002 ) empirical consequences conclude that Marshall Lerner status was hold when he surveies the impact of existent exchange rate for Thailand trade balance with its major trading spouses. Besides that, quarterly informations from 1990 to 2000 was collected for his empirical survey. The consequence from carbon monoxide integrating trial showed that existent exchange rate has important relationship with the Thailand bilateral trade balance. Furthermore, his consequence suggests that existent income does non hold important when determiner the Thailand trade balance.

Similarly, Tochitskaya ( 2007 ) utilizing quarterly informations from 1995:4 to 2004:4 to analyze Belarus economic and trade balance. The OLS arrested development theoretical account consequence that depreciation of exchange rate has a important impact on Belarus trade balance. Therefore, Marshall Lerner status meets. Furthermore, unit root trial carried out the dependent variables and other variables does non demo the relationship in the long tally. However, Rose ( 1991 ) examines that Marshall Lerner status does non satisfied when he surveies the function of exchange rate in 5 major OECD states which are UK, Canada, Germany, Japan and US. The informations are monthly and seasonally adjusted from 1973 to 1986. By utilizing imperfect replacement theoretical account, the findings show that exchange rate is non an of import factor determinant the trade balance.

Kyereme ( 2002 ) chief aim is to research the determiners of trade balance between US and Australia in the long tally. By utilizing co integrating trial and sample informations 1965 to 1998, he found that there is a positive relationship between exchange rate and trade balance. Besides that, the arrested development consequence conducted that monetary value ratio is a major factor determinant the trade balance. Other variables such as GDP ratio, money supply, existent exchange rate and loaning ration besides have important to act upon the trade balance.

Bahmani-Oskooee ( 1991 ) besides applies co integrating analysis to find whether there is a long tally relationship exists between trade balance and existent effectual exchange rate. He study cover quarterly informations from 1973 to 1988 for eight less developed states ( LDC ) , which are Argentina, Bahamas, Bangladesh, India, Korea, Philippines, Greece and Thailand. His concluding determination concludes that Marshall Lerner status satisfied in the LDC trade balance. Further analysis point out the relationship between trade balance and exchange rate were co integrated in the long tally.

A big and legion surveies have concentrating their survey on the relationship between trade balance and exchange rate. Similarly, Kale ( 2001 ) used co integrating method to analyze the relationship for these two variables in the Turkish economic system. This survey used the quarterly informations from 1984:1 to 1996:2 for his model theoretical account. Furthermore, Bickerdike Robinson Metzler status was holds when the devaluation of exchange rate in the long tally improves Turkey trade balance.

In another major survey, Rose ( 1990 ) unable to establish a important relationship between exchange rate and trade balance. In this paper, he used non structural techniques to analyze the impact of the existent exchange rate on the development states. Rose ( 1990 ) used two set of informations which is one-year informations spans 1970 to 1988 and quarterly informations which cover from 1977 through 1987 for 30 developing states. The consequence for his determination is difference with other surveies because existent exchange rate has insignificant impact on the many-sided trade balance for developing states.

Furthermore, Wilson ( 2001 ) besides examines the same consequence with Rose ( 1990 ) when surveies the relationship between exchange rate and trade balance for bilateral trade balance. He chooses Singapore, Malaysia and Korea with USA and Japan on quarterly period which cover the period from 1970 to 1996. By utilizing the Johansen and Granger trial, he suggests that existent exchange rate does non hold a important relationship with the trade balance. Besides that, he found that no grounds of J-curve consequence in Singapore and Malaysia economic system. However, J-curve patterns exists in Korea trade balance when its trade with Japan and USA.

Tai and Lin ( 1998 ) usage farmer causality theoretical account to analyze the Taiwan-Japan trade balance from 1981:1 to 1003: 6. The ADF unit root trial show that the variables which are exchange rate, money supply, end product and monetary value index are integrated. However, Johansen consequences examine that trade balance does non hold co integrating relationship with these four variables. In both short tally and average term, the impulse response analysis point out that the impact of exchange rate on trade balance are lower than the impact of money supply and income. At the same clip, Hui ( 2002 ) besides study the relationship between Taiwan exchange rate and trade balance with Japan and US. The sample size is cover quarterly informations from 1981: to 1998: 4. By utilizing co integrating trial and mistake rectification theoretical account, he suggests that the relationship between exchange rate, export and trade balance are exists in the long tally.

Amano and Norden ( 1995 ) besides apply the same econometric theoretical account with Tai and Lin ( 1998 ) which is Granger causality trial to run the relationship between exchange rate and the term of trade for Canada-US bilateral trade balance. The causality consequence shows that the dazes of term of trade have a important impact on exchange rate. The sample informations usage for their survey is over the 1973M1 to 1992M2. Finally, their surveies conclude that the term of trade dramas an of import function to Canada-US exchange rate, while the pecuniary policy is a 2nd factor determinant the alteration of exchange rate.

Luis et Al. ( 2008 ) chief intent of their survey is to analyze the function of exchange rate in the US and UK trade balance. The sample informations for exchange rate and trade balance are from 1988: 01 to 2005:12. By using the unit root trial and carbon monoxide integrating theoretical account, the consequence were different. The void hypothesis for the unit root trial is rejected for the balance of trade while the hypothesis for the exchange rate does non reject. Thus, in regressive theoretical account, exchange rate dainties as weakly exogenic variable in order to work out this job. Their concluding determination show that the trade balance is non stationary variable and the impact of exchange rate take a long period to vanish.

In order to mensurate the overestimate of rupiah during the Asiatic crisis in 1997, Saxena ( 2002 ) study the exchange rate kineticss in Indonesia over 1980:1 to 1997:4. This survey utilizing the carbon monoxide integrating method, unseen constituent theoretical account and structural vector car arrested development ( SVAR ) theoretical account to analysis the exchange rate policy in Indonesia. Saxena ( 2002 ) empirical consequences show that exchange rate is positively related to the term of trade and authorities outgo. Last, the unseen constituent theoretical account carry out that Indonesia trade balance addition when exchange rate devaluation.

Arize ( 1996 ) chief aim is to analyze the long tally relationship between trade balance and the footings of trade in 16 states. The quarterly informations screen from 1973:2 to 1992:4. Johansen co integrating trial show that the term of trade and the trade balance are co integrated for all 16 states. In the long tally, devaluation of exchange rate improves the trade balance. Marshall Lerner status holds, therefore the monetary value of export and import snap is greater than 1.

Peree and Steinherr ( 1989 ) examine the uncertainness of exchange rate and its effects on foreign trade in US state during the period 1960 to 1985. They use two steps to prove the uncertainness of exchange rate. One is weighted map and the 2nd is depends on the continuance and amplitude of the exchange rate. Their empirical consequences suggest that the uncertainness of exchange rate has negative effects on the trade balance, hence resources allotment besides affects.

Yazici ( 2008 ) investigate and compare the alteration of exchange rate on Turkish three chief economic sectors, which are agribusiness, fabrication, and excavation sector. The empirical work uses the quarterly informations from 1986:1 to 1988:3. By utilizing the Bahmani-Oskooee ( 1985 ) theoretical account which is J-curve footings, Yazici ( 2008 ) found that J-curve form exists in these three sectors. When exchange rate devaluation, the trade balance for these sectors ab initio increase so worsen and so increase once more. In the short tally, all three sectors reaction to the alteration of exchange rate, while in the long tally, these three sectors do non exhibit the similar manner with exchange rate.

Alam ( 2010 ) look into the volatility of exchange rate on Pakistan sum exports demand during 1979 Q3 – 2005 Q4.The ADRL analysis show that the existent export are co incorporate with the foreign economic activity, exchange rate and the volatility of exchange rate. Besides that, the short tally dynamic causality did non found from the volatility of exchange rate on Pakistan sum export demand.

3.0 Introduction

This chapter discusses the belongingss of times series and some econometric theoretical account to look into the relationship between exchange rate and trade balance in Norway. In this survey, I will utilize the Unit root trial and Ordinary Least Square ( OLS ) theoretical account to mensurate the empirical consequences. Besides that, Multiple Linear Regression applies in this chapter because two independent variables are used.

3.1 Datas Beginnings

In this survey, times series informations are cover from twelvemonth 2000 to twelvemonth 2009. This one-year informations were obtained from assorted beginnings. For the export, import and trade balance, the information beginnings are come from U.S. Census Bureau, Foreign Trade Division, Data Dissemination Branch, Washington, D.C. 20233. The information for Norway exchange rate obtain from Federal Reserve System while the informations for rising prices rate collected from CIA World Factbook.

3.2 Hypothesis Formulation

In order to prove the relationship between these variables, we can province an premise in hypothesis. However, this premise may or may non be true. There are two types of statistical hypothesis, which are void hypothesis and alternate hypothesis. In this survey, these hypotheses would be expressed as:

Holmium: I?1=I?2=0 ( insignificant )

H1: I?1a‰ I?2a‰ 0 ( important )

3.3 The theoretical account Specification

In this survey, the multiple arrested development theoretical account used is as below:


Where Y= trade balance

I±=the Y intercept

I?=regression of coefficients

X1=exchange rate

X2= rising prices rate

Aµt=error term

The relationship between dependant and independent variables are below:

Trade balance- Dependent variable which is being predicted. Trade balance is export less import. Trade balance excess exists when export more than import, while trade balance shortage occur when import more than export.

Exchange rate- Independent variable and usage to determinant whether the exchange rate volatility can impact the trade balance. When exchange rate devaluation, trade balance will better. However, balance of trade will shortage when exchange rate grasp.

Inflation Rate- Another independent variable usage to prove the carbon monoxide integrating relationship with the trade balance. The addition of rising prices rate in national will increase the monetary value degree at state. Therefore, it causes the import for state more than export, and presents the trade shortage.

3.4 Method of Analysis

The Multiple Regression Models is an econometric technique usage to analyze the relationship between dependant and independent variables. More specifically, Multiple Regression Analysis enables us to understand how the dependent value will alter when independent variables is varied. The signifier of the multiple arrested development theoretical accounts as below

Y=I±+I?1X1+I?2X2+I?3X3+aˆ¦aˆ¦ I?n Xn+ Aµt

to explicate the behaviour of the dependant variable. The Aµ is known as stochastic mistake term or merely an unobservable random variable taking positive or negative. We shall analyze the nature of stochastic perturbation term, but for the motions assume that it is a placeholder for all the omitted variables that may impact Y but are non included in the arrested development theoretical account.

3.4.1 The method of Ordinary Least squares ( OLS )

In arrested development analysis, OLS is a popularly method used by calculators because it has really strong theoretical belongingss, which are known as the Gauss-Markov Theorem. Under the premise of classical additive arrested development theoretical account ( CLRM ) , the OLS have minimum discrepancy, so they are BLUE ( Best Linear Unbiased calculators ) .

3.4.2 Fit of the Regression Model

The goodness of tantrum in the arrested development theoretical account can be assessed by the coefficient of multiple findings, denoted by the symbol R2. Now, allow us specify



=1- ( a?‘ Ui2 / a?‘ yi2 )

Now a?‘ yi2 is the independent of the figure of X variables in the theoretical account. The RSS, a?‘ Ui2, nevertheless, depends on the figure of regressors present in the theoretical account. To compare two R2 footings, one must taken into history the figure of X variables nowadays in the theoretical account. Therefore, we consider the adjusted R2, denoted by a??2. The a??2 is a alteration of R2 that adjusts for the figure of term in a theoretical account.

3.4.3 F-test

We use F-test to prove the important of a multiple arrested development because the mugwumps variables are more than one. We reject Ho if calculated F & gt ; critical value.

F= ( ESS/k-1 ) / ( RSS/n-k )

Set up the appropriate nothing and alternate hypothesis:

Holmium: I?1=I?2=0 ( invalid )

H1: Not all the incline coefficients are at the same time zero ( valid )

If F & gt ; Fa ( k-1, n-k ) , we reject Ho. The fittingness of theoretical account is good because the higher F, the higher R2 will show.

3.5 Unit Root Test

Unit root trial is a statistical method to trials whether a clip series informations is non stationary or stationary. We start with

Yt = pYt-1 + Greenwich Mean Time -1a‰¤ pa‰¤ 1

If p = 1, that we have a unit root, intending the clip series under consideration is non stationary. However, we can non gauge and prove the hypothesis that p=1 by T-test because the trial is biased in the instance of a unit root. Therefore, we regress Yt and lagged one period to Yt-1 and happen out whether the estimated P is statistically equal to 1? Now we subtract Yt-1 from both sides to obtain:

Yt -Yt-1= pYt-1 – Yt-1+ Greenwich Mean Time

= ( p-1 ) Yt-1+ ut

This can be instead written as

I” Yt = I? Yt-1+ Greenwich Mean Time

If I? =0, so p = 1. So, the clip series informations is non stationary ( unit root ) . The most celebrated unit root trials are Augmented Dickey Fuller ( ADF ) trial and Phillips-Perron trial. Both of these trials use the being of a unit root as the void hypothesis.

3.5.1 Augmented Dickey Fuller ( ADF ) trial

In ADF, we still test whether I? =0 and the ADF trial follows the same asymptotic distribution as the DF statistic, so the same critical value can be used. The ADF theoretical account can be applied by as:

I” Yt = I± +I?t + I? Yt-1 +I?1 I” Yt-1 +aˆ¦aˆ¦ + I?p I” Yt-p + E›t

Where I± is changeless, I? is the coefficient and the P is the slowdown order for the autoregressive procedure. The ADF trial is merely valid for AR ( 1 ) .To test the higher order autoregressive, the slowdown of the order P has to use into the trial. Another alternate attack to analyze the information standard is Akaike and Schwarz.

3.5.2 Phillips and Perron trial

Phillips and Perron trial besides address the same consequence as the ADF trial. They use nonparametric statistical methods to take attention of the consecutive correlativity in the mistake footings without adding lagged difference footings. To prove a unit root, we reject Ho when the statistical value less than critical value.