An inquiry into exchange rate misalignments as a cause of major global trade imbalances

Abstract

Purpose In the context of debate on competitive devaluation and trade imbalances, the purpose of this paper is to investigate the role of exchange rate misalignment as a determinant of trade imbalances in selected major trade surplus (Germany, China, Japan, Russia and KSA) and major trade deficit countries (USA, UK, France, India and Turkey). Design/methodology/approach The authors used a structural vector auto-regressive model on data from ten countries with the highest trade deficit and surplus. The period of analysis is from 2000 Q1 to 2016 Q1. Findings The key findings suggest that although exchange rate misalignment from equilibrium may have some implications for the current account balance for surplus and deficit countries, the effects observed were rather very mild and transitory. There was a heterogeneity in the response of the current account position to exchange rate misalignment in each country, concomitantly; the exchange rate misalignment shall not be seen as the sole responsible factor in the debate on global trade imbalances. Research limitations/implications The research has profound implications in terms of exploring the notion of competitive devaluation and exchange rate misalignment as a cause of major global trade imbalances. Practical implications This study has important practical implications for the trade policy of major economies in the world. These are twofold. First, this study has analysed and reported on the degree of misalignment of exchange from its equilibrium values in the major trade surplus and deficit countries. Second, it has investigated the implications of any misalignment for the trade balance or respective economies. Social implications There are important social implications as the notion of competitive devaluation and exchange rate–trade balance nexus has been heavily politicised. This study provides an empirical insight and an answer to these claims which have social and political implications. Originality/value There is a significant element of originality and contribution to the existing body of knowledge on the subject. In the context of debate on competitive devaluation this is the first study which has investigated whether the exchange rate has been misaligned from its equilibrium values (competitive devaluation) and whether there is some nexus between the real exchange rate misalignment and trade imbalances in under-analysis economies.