Bilateral Trade Balance between Korea and Her Trading Partners: the J-curve Effect

The primary purpose of this paper is to examine the short-run and long-run relationships between trade balance and real exchange rate using bilateral data for Korea vis-à-vis ten of her major trading partners on a quarterly basis over the period of 1990Q1 to 2006Q1. Based on the ARDL bounds test, we find evidence of cointegration for 7 out of the 10 trading partners. The result also shows that a depreciation of the won leads to a long-run improvement in Korea s bilateral trade balance vis-à-vis the USA, Japan, Germany, China and the UK. Our finding of the long-run negative (positive) relationship between domestic (foreign) income and the domestic bilateral trade balance appears to be supportive of the general view, in the case of Korea, that emphasizes the demand effect of both domestic and foreign income on the domestic trade balance. The evidence of short-run J-curve phenomenon is present rather weakly in Korea s bilateral trade with the UK, Germany and China. A real depreciation of the won, however, leads to an initial improvement in Korea s bilateral trade balance with many countries.