An Empirical Analysis of the Trade Balance of Pakistan Using the Elasticities, Monetary, and Absorption Approaches

Abstract

This study attempts to estimate the trade balance of Pakistan by developing a model that incorporates the three major approaches, i.e., absorption, elasticities, and monetary, for a time ranging from 1971 to 2021. Autoregressive Distributed Lag (ARDL) model is used to estimate the short-run and long-run response of GDP growth, broad money growth, and real effective exchange rate to trade balance. The results show that the real effective exchange rate is negatively related to the trade balance of Pakistan both in the long run and short run. This indicates that variation in the exchange rate does not improve the trade balance. The study also does not confirm the existence of the J-Curve in Pakistan. The GDP growth has a statistically insignificant impact on the trade balance in the short run while negatively related to the trade balance in the long run. The broad money growth is negatively related to trade balance in the short run as well as in the long run. The long-run effect is higher than the short-run effect. The monetary authority should adopt an appropriate monetary policy to improve the adverse balance of payments in Pakistan.