Korean Bilateral Trade Balances and Exchange Rate Sensitivity: Evidence from the Panel Approach

The primary purpose of this paper is to examine the effects of bilateral real exchange rate on the bilateral trade balances for Korea vis-à-vis thirteen of her major trading partners using the most recently developed panel cointegration techniques, thereby improving the power performance of the relevant estimation and inference procedures. The panel cointegration statistics reject the null hypothesis of no cointegration in all tests except the panel variance test with time dummies, implying that trade balance is cointegrated with the real exchange rate, domestic income, and foreign income at both bilateral and panel levels. In both between-dimension FMOLS and DOLS, the three panel coefficients of the real exchange rate, domestic, and foreign real income variables carry correct signs and are statistically significant at the 1% level. The most important implication of this panel study is that, in the long run, real exchange rate changes remain as one of the most effective determinants of the Korean trade balance.