An Empirical Analysis Of Exchange Rate Volatility And Trade Flows

Exchange rate is an important relative price index in economy, the exchange rate regime plays an important role in improving the external economic relations and maintaining the stability and development of an economic system. Since the collapse of the Bretton Woods system, the floating exchange rate system mounted the historical arena, the fluctuations of nominal exchange rate and real exchange rate became the normal state of the world economy. The core of dispute between the fixed exchange rate regime and the floating exchange rate regime is if the increasing exchange rate volatility would lead to the decrease of international trade. A large number of subsequent empirical studies did not make a consistent conclusion. The results of the empirical studies revealed that the impact of the exchange rate volatility on the international trade was not necessarily negative, sometimes insignificant, or even positive . The reasons causing different empirical results are that the target countries, the sample time and the calculation methods which researchers selected are different. At the same time, the previous researches mainly chose developed industrial countries as study objects, and these countries had huge differences with a large number of emerging market economies including China in the economic characteristics, which did not necessarily come to the conclusions suiting for developing countries. This paper chooses the emerging market economy country--Korea to conduct empirical research, by comparing the impacts of exchange rate volatility on the import and export under different exchange rate regimes before and after the Asia Financial Crisis, and does the comprehensive study of the impact of exchange rate volatility on the trade flows. This can not only do empirical testing for previous theoretical achievements, but also give some experience for the emerging trading nations– China which explores on the road to reform the exchange rate system.This paper includes five parts. In the first part (Introduction), the theoretical and practical significance of this subject is introduced, the relevant research of scholars overseas is outlined, the structure and the main viewpoints of this paper are introduced,and the author's creativity and the main inadequacy are also given.The second part summarizes the relationship between the exchange rate regime and the trade flows. The study method in exchange rate volatility which using the GARCH (1,1) model to calculate the real exchange rate volatility is introduced. Then the general equilibrium model to analyse the relation between the exchange rate volatility and trade flows is built.The conclusion from the analysis is that: If the currency exchange rate is the tendency of the appreciation, the trade volume will be reduced in the future; if the exchange rate is the tendency of depreciation, it will expand the scale of trade; if the exchange rate is the random fluctuations, increased exchange rate volatility will do no impact on trade scale.In the third part, the change of exchange rate regime and the trade development in Korea before and after the Asian financial crisis is outlined. The exchange rate regime of Korea has experienced generally pegged exchange rate regime, managed floating exchange rate regime and the free-floating exchange rate regime. The outbreak of the Asian financial crisis prompted the Korea to carry out the reformation of the financial mechanism, and gradually gave up foreign exchange control. In the corresponding period, the Korea's trade patterns have changed from the Import Substitution to Export-oriented and then developed to the internationalization and liberalization stage.In the fourth part, the empirical study which selects the Korea as a sample is conducted by using measurement tools.This research is to inspect the impact of exchange rate volatility on import and export of Korea in different phases-- before and after the Asian financial crisis. The basic conclusion of this empirical research is: In the short term, the impact of exchange rate volatility on the trade is not significant; in the long term, exchange rate volatility inhibits export and its impact on imports is uncertain. This result is very different from the conclusions of many studies in developed countries. The reasons which cause these differences lie in the different levels of economic development and openness between countries, the different sizes of trade and economic development policies, and other factors tended to be in relation. Although the exchange rate volatility do not significantly influence the volume of trade in the short term, in the long term , through the relevant conduction mechanisms, it will inhibit trade, in particular the increase in export. For China, a developing country using the trade development as the driving force for growth, faces the same problem of the choice in exchange rate regime. The reform of the formation mechanism of the exchange rate is only a start, and the inspection on Korea would be able to provide us some lessons.In the fifth part, combining with the empirical study of Korea, in view of China's exchange rate system reform and the "double surplus" situation, three useful inspirations can be drawn: Firstly, if a country makes the important policy target to promote export, it should take relatively fixed exchange rate regime. For China which is at the level of emerging market country instead of the developed country, taking a floating exchange rate system may result a certain degree of negative impact on the export; Secondly, the choice of exchange rate regime is an endogenous process of institutional change, it is a result which many variables lead to. China should consider its own economic characteristics and policy objectives, and actively promote the reform of the exchange rate formation mechanism; Thirdly, on the process of choosing a desired exchange rate regime, the country should master suitable time, choose a smooth gradual transition order and proceed the positive financial reform. The time of exchange rate mechanism reform in China is appropriate, but China still need to design a long-term stable transition order and provide strong financial security for the exchange rate reform.