The Effects of Different Components of Exchange Rate on Trade Balance: A Signal Extraction Approach

The paper investigated the relationship between exchange rate and trade balance in a signal extraction framework. The exchange rate uncertainty was decomposed into three components and the cointegration relationship was indentified by bounds test. The effects of different components on trade balance were researched respectively at first, and then we employed the recursive estimation methodology to plot the dynamic process of the exchange rate effects on trade balance. The results show the following conclusions: 1) The real effective exchange rate has a significant impact on trade balance in recent years. 2) The effects of public-known component on trade balance of three type enterprises are similar, but the effects of signal component are different. 3) The effects of exchange rate on trade balance are variable and becoming weak in recent years.