The balance of trade is the difference between exports and imports of the goods and services in one state, it can be favorable excess when exports more than imports, or unfavorable shortage when imports exceed exports. Robinson ( 2004 ) stated that a trade balance excess ensuing from higher value of exports to value of imports can bring forth more income and hike up the populating criterion of one county. On the other manus, the trade shortage will restrict the growing of populating criterion in a state because of the net money escape due to exports value received less than imports value paid.

Harmonizing to Durand and Giorno ( 1987 ), trade balance is one of the major indexs of a state ‘s position in international trade. It provides a manner to placing economic instability of the states and allows them to guarantee they sell plenty to pay for what they buy abroad. By sum uping the net export with the full foreign sector, economic experts can analyse one state ‘s trade public presentation and the position for economic system growing based on the trading information.

Blecker ( 2011 ) stated that the trade balance of United States ( U.S. ) was suffered a long term declining tendency in their current history and caused their balance of trade has risen more or less steadily during last three decennaries. Over these old ages, U.S. trade shortage reached the historical high of $ -753.3 billion in 2006 and has held shortage place in trade balance until now, reported $ -559.9 billion in 2011 with the entire imports of $ 2.67 trillion and the entire exports of $ 2.11 trillion ( U.S. Bureau of Economic Analysis [ BEA ], 2012 ).

Similarly, Sandle ( 2012 ) stated that, based on the economic information, the trade shortage in U.S. became wider in 2011 and the spread between imports and exports increased by 13.17 % comparison to $ 494.7 billion in 2010. With mention to the survey done by Oak ( 2012 ), the U.S. trade shortage is generated by trading of ware and reduced by service activities. Since trade shortage of ware was $ -91.2 billion and trade excess of service was $ 33.2 billion in 2011, the addition on service is non adequate to cover the loss on ware, hence created a trade shortage to U.S. ( BEA, 2012 ).

Meanwhile, U.S. besides imported a batch of consumer merchandises, such as vesture, machines, family merchandises and so on, and ran a $ 326 billion shortage in 2011 and by import $ 483 billion while merely export $ 157 billion. Given the ground that U.S. has deficient merchandises on demand, the domestic demand is satisfied by import from foreign, and besides because of the imported wares is much cheaper than domestic merchandises ( Nanto & A ; Donnelly, 2010 ). The top five major merchandising spouses listed by Rosenberg ( 2007 ), whose export have important power to impact U.S. ‘s trade shortage state of affairs, exported most of the ware and consumer goods to U.S., which are China 16.9 %, Canada15.7 %, Mexico 10.6 %, Japan 7.4 % and Germany 7.3 % ( BEA, 2012 ).

Lum and Nanto ( 2006 ) reported that China is presently the United States ‘ second-largest trading spouse, its third-largest export market, and its biggest beginning of imports. It is because U.S. imports from China have risen much more quickly than U.S. exports to China, the U.S. ware trade shortage has grown from $ 10 billion in 1990 to $ 296 billion in 2011 ( BEA, 2012 ). Besides that, China ‘s cheaper assembly had already attracted U.S. ‘s manufacturers for directing natural stuffs to them in order to bring forth the production in lower cost and purchase back from China. Harmonizing to Kimberly ( 2012a ), this trading scheme had enlarged the volume of imports and it was caused the U.S. trade shortage with China in a largest proportion.

Apart from that, BEA ( 2012 ) reported that U.S. trade shortage in 2011 with Japan was $ 62.6 billion, a 4.3 % addition over 2010 and for 8.6 % of the overall U.S. trade shortage. Following, the U.S. trade shortage with Germany is merely $ 49.3 billion with the exports $ 49.1 billion and the imports about twice every bit much $ 98.4 billion. Meanwhile, the U.S. has a trade shortage with Canada that is merely 5 % of entire trade. Canada is U.S. ‘s largest trading spouse, so a little shortage does n’t bespeak that the trade is out of balance, it exports $ 280.9 billion and imports $ 316.5 billion. Furthermore, Canada, U.S. and Mexico are spouses in the universe ‘s largest trade understanding, North American Free Trade Agreement ( NAFTA ) ( Kimberly, 2012b ). The trade shortage with Mexico was $ 65.6 billion with the exports of $ 197.5 billion and the imports of $ 132 billion.

Jackson ( 2012 ) argued that the U.S. trade shortage was besides generated significantly by importing oil- and petroleum-related merchandise. Oil is a critical resource for the U.S. economic system. It meets about 40 % of entire U.S. energy demands, including 94 % of the energy used in transit and 40 % of the energy used by the industrial sector ( Nerurkar, 2012 ). From the study of BEA ( 2012 ), rough oil is the most major import good by U.S., which was about $ 341.9 billion and obtained 16.3 % to entire imports. Based on a survey done by Whitney, Behrens and Glover ( 2011 ), U.S. has non plenty of oil resources to bring forth sufficient energy to whole county from last three decennaries. For this ground, U.S. had imported immense sum of oil-related merchandise from members of Organization of the Petroleum Exporting Countries such as Saudi Arabia, Venezuela, Russia and others ( Rousseau, 1998 ). Despite the diminutions in net import volumes of oil in past three old ages, Jackson ( 2012 ) proved that the cost of cyberspace imports has by and large increased is due to lifting oil monetary values, it made the oil imported issue become more and more of import in U.S. trade balance.

Harmonizing to Blecker ( 1999 ), the U.S. trade shortage was besides caused by the relentless worsening fight and trade barriers abroad. The diminution in U.S. industrial investing had been rather important, U.S. net exports had declined and net investing in fabrication had besides declined ( Richman, Richman & A ; Richman, 2011 ). From 1960s to 1980s, manufacturers of U.S. are losing their competitory advantage to their trading spouses. Kim and Nelson ( 2000 ) explored that it happened because of the technological catch-ups in Western Europe and Japan tends to decelerate down the productiveness growing in U.S. Furthermore, the rise of freshly industrialising states ( NICs ) such as Hong Kong, Korea and Taiwan, make the U.S. trade balance became even worse ( Branson, 1987 ). NICs increase their capableness in bring forthing the manufactured merchandises with well lower labor costs and advanced engineering than U.S. ( Chinn, 2005 ).

In add-on, trade barriers imposed by foreign states besides widened the trade shortage in U.S. Elwell ( 2008 ) stated that the greater trade barriers abroad frequently included expressed trade policies such as duties, quotas, and other formal trade limitations. But trade limitations do non significantly find the overall U.S. trade shortage, nor do they to the full account for the differences in bilateral trade balances. Nevertheless, Griswold ( 1998 ) argued that U.S. runs a big trade excess with Brazil, a state with comparatively high trade barriers, while U.S. runs shortages with Mexico and Canada, two states virtually unfastened to U.S. exports.

## 1.2 Problem Statement

Over the old ages, trade instability is a most of import issue for international trade which consists of all developed and developing states. Developing states such as Malaysia ( Duasa, 2007 ) and Pakistan ( Waliullah, 2010 ) had found the job of trade shortage for long times due to their import ever exceed their export.

However, the trade balances of certain developed states besides fell in shortage in 2011 such as U.S., United Kingdom, Australia, Canada and Germany ( BEA, 2012 ). Among the developed states, trade shortage in U.S. is the issue that attracted attendings from many research workers, merely due to U.S. is the universe ‘s largest economic system with their powerful bargaining place and extremely efficient trading system ( Heinbecker, 2004 ). In fact, the U.S. dollar is the most traded currency in the Earth, so it stands for ground that anything that happens with the U.S. economic system will impact fundss internationally ( Nanto & A ; Donnelly, 2010 ). In conformity to Gould and Ruffin ( 1996 ), Blecker ( 1999 ) and Elweel ( 2008 ), there are many factors impacting the balance of trade such as the exchange rate motions, national income, money supply, fight, non-tariff barriers abroad and costs of production.

In instance of U.S., trade shortage was affected by deficits of nest eggs in the domestic economic system and heavy trust on foreign financess imports to finance the deficit. As Frank ( 2005 ) mentioned that a nest eggs deficit is similar to excessive disbursement that is financed by borrowing, such as families borrow for ingestion, concerns borrow for investing and the authorities borrows for financing its budget shortage. By and large talking, U.S. current history shortage is in danger of falling into a barbarous circle, as the adoption required to finance this shortage makes U.S. international debt grows. Harmonizing to what Gould and Ruffin ( 1996 ) had told, salvaging has the analytical advantage of rooting the phenomenon in the minutess on international plus markets, which is the key to understand the sum trade instabilities.

Mauldin ( 2008 ) besides agreed that deficiency of salvaging compared to ingestion will do trade shortage. As what Mauldin commented if the U.S. nest eggs rate has steadily declined from about 10 % in the sixtiess to zero in this decennary. Since 2004, the U.S. nest eggs rate has been either negative or less than 1 %. If U.S. consumers merely saved 5 %, as they did 10 old ages ago, the trade shortage would cut down by a batch. Hendrik and Stephen ( 1969 ) have found that the “ ( national ) income snap of U.S. demand for import ” is significantly higher than the “ income snap of U.S. demand for export ”, which means a rise in same degree of national income, the U.S. increases its purchases of imports in higher proportion than other states increase their purchases of U.S. exports. Therefore, trade shortage frequently happens in U.S. with higher national income.

Furthermore, Elwell ( 2008 ) found that the domestic demand for loanable financess exceeds the domestic supply of loanable financess in U.S., this causes the domestic economy falling short of desired domestic investing in U.S. and accordingly tends to do comparatively higher domestic involvement rates. Therefore in the instance of U.S., high involvement rate will pull influxs of foreign economy and the influxs will prolong its domestic investing. Henceforth, U.S. became a net importer of foreign salvaging so that they able to prolong their domestic investing every bit good as get foreign end product by utilizing the borrowed buying power, and eventually decline the trade balance.

Elwell ( 2008 ) besides clarified that U.S. was utilizing international adoption to force disbursement beyond current production, prosecuting desired ingestion and productive investing now instead than subsequently. Corsetti and Konstantinou ( 2012 ) further agreed that the adoption from abroad will do U.S. addition good being of current coevals, but the net consequence of the adoption will be to switch the load of refund to future coevalss without a corresponding benefit to them.

Elwell ( 2012 ) had proved that the high existent involvement rates and fiscal volatility abroad had attracted huge influxs of fiscal capital into the U.S. market. U.S. dollars appreciate than other states and their exchange rate will be travel up and caused U.S. merchandises less price-competitive, therefore decelerate down the chance for export, created trade shortage. Harmonizing to Blecker ( 1999 ), the consequence from the involvements of the fiscal sector had brought the disadvantage manufacturers of tradable industries, agricultural merchandises and service in the United Stated.

On the other manus, Wu ( 2011 ) found that the depreciation of currency may make a penchant for domestic goods, positively impacting domestic end product and the trade balance. In other word, depreciation makes foreign goods become more expensive and affect people to diminish their import.

## 1.3 Research Aims

## 1.3.1 General Objective

To analyze the long tally relationships between trades balance and existent national income, money supply, and existent exchange rate in the instance of U.S. economic system.

## 1.3.2. Specific Aims

To analyze whether there is a negative relationship between existent exchange rate and trade balance in long tally.

To analyze whether there is a negative relationship between existent national income and trade balance in long tally.

To analyze whether there is a negative relationship between money supply and trade balance in long tally.

## 1.4 Research Questions

Is there a negative relationship between existent exchange rate and trade balance in long tally?

Is there a negative relationship between existent national income and trade balance in long tally?

Is there a negative relationship between money supply and trade balance in long tally?

## 1.5 Significances of Study

This survey is intended to lend to the several survey on U.S. trade instability, with the ultimate aim of narrow down or cut down the badness of U.S. trade instability, peculiarly the ‘vicious rhythm ‘ of trade shortage, through the resulting deductions of this survey. As to the best of our cognition, there are several researches were done in developing states such Malaysia ( Duasa, 2007, Ng, Har, & A ; Tan, 2008 ) and Pakistan ( Waliullah, Kakar, Kakar, & A ; Khan, 2010 ) sing the behavior of trade balance by integrating all the proxy clip series variables within a co-integration model, but there is merely small were conducted in developed states, despites the single analysis between one or two determiner and trade balance etc. Therefore this paper is expected to assist in make fulling this literature spread.

## 1.6 Chapter Layout

In this survey on U.S. trade balance, the overview of this study/research is presented in Chapter 1, so relevant literatures in our field of survey are reviewed under Chapter 2, following that the overall methodological analysis of analysis is elaborated in Chapter 3 and the empirical consequences are reported and interpreted in Chapter 4, in conclusion, the major findings, policy deductions and decision are discussed in Chapter 5.

## Chapter 2: LITERATURE REVIEW

## 2.1: Reappraisal of Literature

## 2.1.1 Trade balance

Trade balance is one of the major constituents in the current history which is associated with export and import of a state. Both Gilchrist ( 1916 ) and Fetter ( 1935 ) agreed that the favourable trading position for a state was referred to export more than import, which is besides normally known as trade excess. However, it is non entirely intend that all imports will harm the trade balance and economic growing of a state, because it instead depends on the types of imported goods by the state. Asad, Ashraf, Ghazali, Raza & A ; Rehman ( 2011 ) pointed out that, imported natural stuff can convey value-added to a state ‘s sum end product through the production and ingestion concatenation and so promote the economic growing and export of the state.

Erceg et Al. ( 2005 ) accomplished a survey on the effects of expansionary financial policies on the trade shortage. They concluded that revenue enhancement tax write-off and increase on authorities outgo could hold important immense impact on the trade shortage that confronting by U.S. Mann and Pluck ( 2007 ) found that ingestion for consumer goods had became an imperative factor to the prevailing tendency of U.S trade shortage. Ferrero. A ( 2010 ) argued that productiveness growing and demographic factor was the chief constituents that could impact the U.S trade balance. Chinn ( 2004 ) had concluded that existent exchange rate could impact the export for U.S whereas income snap would impact both export and import of U.S. Salvatore ( 2007 ) stated that trade shortage in U.S. could harm the growing of universe economic system and he suggested that an addition in the economy for private and public would assist to better the trade shortage.

Gulzar ( 2011 ) examined four factors that might impacting the trade balance in Pakistan, the factors are foreign direct invest ( FDI ), domestic economy, fabricating growing rate and agribusiness growing rate. His survey showed that all of the four factors have positive relationship with balance of trade. Another cross-countries analysis on trade balance affecting 32 industrialised or emerging economic systems was completed by Falk ( 2008 ) to analyse other factors of trade balance, which includes authorities budget, existent foreign gross domestic merchandise ( GDP ) per capita and domestic GDP per capita. He determined that these factors while authorities budget and foreign GDP are significantly and positively act upon the trade balance, while the relationship between domestic GDP and trade balance was found significantly negative. His determination is agreed to the common wisdom that an addition in one ‘s income will do one to devour more by increasing import, so an addition in domestic GDP will be given to increase domestic demand for foreign goods via lifting imports ( Goldstein & A ; Khan, 1985 ).

Additionally, the grade of trading openness could besides impact the trade balance. Ju ( 2010 ) argued that trade liberalisation is an of import factor to positively impact the trade balance, yet Paulino and Thirlwall ( 2004 ) stated that trade liberalisation could deteriorate the trade balance because trade liberalisation could increase the export and import of a state but at the same. Despite that, Ratnaike ( 2011 ) found that trade liberalisation had no important consequence on trade balance and suggested that the domestic market fight was the right factor to impact trade balance.

## 2.1.2 The Relationship between Trade balance and Real Exchange Rate

The existent exchange rate or exchange rate was widely accepted by most of the economic experts that the alterations of it would hold strong influences to merchandise balance, because it represents the monetary value of currency of one economic system. Given the fact that a depreciation of existent exchange rate of a state is tantamount to a comparatively lower monetary value of currency, a depreciation of existent exchange rate of one state tends to pull demand for the state ‘s merchandises because its goods are inexpensive compared to other states. Therefore, a depreciation of existent exchange rate would do an addition in the export for the several state.

However, there is one celebrated theorem named as Marshall-Lerner status, which stated that the currency depreciation will ab initio diminish the export value of a state, while the betterment consequence on trade balance is come at subsequently after the trading spouses of the state made their accommodations ( Blanchard, 2011 ; Davidson, 2009 ). The currency devaluation reduces the monetary values of exporting goods, therefore at first, the net export value will be decreased because of the lower monetary values of exports. Merely so the aliens realize the lower monetary values and increase their demand for the peculiar exports consequently. Therefore, the negative relationship between existent exchange rates and trade balances were frequently happened after some slowdowns of clip.

Numerous researches had proven the negative relationship between existent exchange rate and trade balance for assorted economic systems, such as China ( Wang, 2007 ), Vietnam ( Thanh & A ; Kalirajan, 2006 ), Croatia ( Stucka, 2003 ) every bit good as other industrialized or emerging economic systems including United States ( U.S. ), United Kingdom ( U.K. ), Japan, South Korea, Austria, Finland and so on, which were being studied in the cross-panel analyses that conducted by Falk ( 2008 ), Algieri ( 2009 ), and Rawlins ( 2009 ). All of the mentioned surveies supported that existent exchange rate is negatively related to the trade balance in their several concerns.

Apart from that, Numberss of surveies were designed to look into whether alterations of existent exchange rate would significantly impact trade balance in the long tally. Bhattarai & A ; Armah ( 2005 ) argued that the negative relationship between existent exchange rate and trade balance did happen in long tally economic system of Ghana, with their cointegration analysis based on Johansen cointegrating model. Similar statement is made based on analyses on single states such as Argentina ( Matesanz & A ; Fugarolas, 2009 ), Thailand ( Brahmasrene & A ; Jiranyakul, 2002 ), Malaysia ( Ng, Har, & A ; Tan, 2008 ), and Serbia ( Petrovic & A ; Gligoric, 2009 ). Except the survey on Serbia which adopts both autoregressive-distributed slowdown attack and Johansen cointegrating attack, all surveies have utilized Johansen cointegrating model entirely.

Furthermore, cross-countries analysis such as paper of Chiu, Lee and Sun ( 2010 ) had analyzed the relationship between currency devaluation and trade balance in the instance of U. S. and its 97 trading spouse by utilizing heterogenous panel co-integration method and concluded that a long tally negative relationship exists between the existent exchange rate and the bilateral trade balance for U. S. Other cross-panel surveies made by Shirvani and Wilbrate ( 1997 ) every bit good as Boyd, Caporale and Smith ( 2001 ) that involved 6 and 7 states severally had given decisions of existent exchange rate is negatively related to merchandise balance in long tally.

However, some mentions such as a survey on Japan ( Shao, 2008 ) argued that currency devaluation may non be able to impact the trade balance in the long tally. The consequence was made with the utilizing of vector mistake rectification mold ( VECM ).

## 2.1.3 The Relationship between Trade balance and Real National Income

Harmonizing to a research done by Asad et Al. ( 2011 ) in Pakistan, they found that import for the natural stuffs and intermediate goods is of import to better the economic growing of a state by exciting the production industry for the state, therefore the state can do international trade with foreign state, and hence export for the state will increase.

There were surveies designed to analyze the relationship between national income and trade balance. Two of them were the documents of Duasa ( 2007 ) and later Ng et Al. ( 2008 ) that examined the determiners of the trade balance in Malaysia. Both consequences indicated that existent national income is a important determiner to positively affect balance of trade in long tally economic system of Malaysia, which reasoning that economic growing would better trade balance in Malaysia. Waliullah, Kakar, Kakar, and Khan had made ( 2010 ) another survey sing trade balance in Pakistan. With the use of ARDL attack, their consequence showed that the existent national income is one of the chief determiners to positively impact the trade balance in Pakistan. Similar decision had been made in the survey of Petrovic and Gligoric ( 2010 ) in regard to the trade balance in Serbia.

However, Chiu et Al. ( 2010 ), Falk ( 2008 ) every bit good as Wang ( 2007 ) argued that the relationship between domestic income and trade balance was negative in the instance of U.S. and in the instance of China severally.

From the literatures we can see the contention on the relationship between national income and trade balance, and there is besides contradict position to the conventional cognition that national income is negatively related to merchandise balance. Following the classical position, the relationship between existent national income and trade balance can be either positive or negative since it depends on how the state apportion its increased income. Supposed that the domestic existent income of a state addition, if the addition in domestic income is allocated to the production of import-substitute goods, the production is expected to increase exports and cut down import demands at the same clip, and eventually better the trade balance.

## 2.1.4 The Relationship between Trade Balance and Money Supply

Initiated by Frenkel ( 1971 ), all else being equal, pecuniary theory of balance of trade emphasiss that if the domestic supply of money is greater than the domestic demand for money, the extra retention of money tends to increase the outgo, imports will increases in bend to fulfill the increased local demand for goods, and finally deteriorates the trade balance ( Melvin, 2003 ).

Craig ( 1981 ) had accomplished a survey on the pecuniary attack of balance of trade and found that the relationship between trade balance and money supply was negatively related, given that the exchange rate and income is changeless. Liew, Lim, and Hussain ( 2003 ) suggested that trade balance is instead affected by existent money than exchange rate in their survey based on ASEAN states. Duasa ( 2007 ) and Walliulah et Al. ( 2010 ) found that the Malayan trade balance and Pakistan trade balance could be improved by cut downing domestic money supply since they are negatively related.

Ivrendi & A ; Guloglu ( 2010 ) had examined the relationship between pecuniary policy and trade balance by following method of Structural VECM. They argued that money supply, in contrast to the above findings, does non hold important impact on trade balance in the long tally in the selected five states which are New Zealand, Canada, Sweden, United Kingdom and Australia. Based on their consequence, pecuniary contraction which is lessening in money supply could better the trade balance in the short tally but it does non impact the trade balance in the long tally. They besides concluded that the consequence was important with the theory which is the money supply can non impact the trade balance in the long tally due to neutrality of money. Duasa ( 2004 ) had done a survey for the two attacks which is Keynesian attack and pecuniary attack on Malaysia ‘s balance of trade. He constructed the survey by utilizing multinomial distributed-lag process and the consequence indicated that money supply does non hold important impact on balance of trade.

## Chapter 3: Methodology

## 3.0 Introduction

In this chapter we introduce the proposed empirical theoretical account for our survey aim in subdivision 3.1 and the associated variable/series and informations in subdivision 3.2, every bit good as the three major stairss of the methods used for this survey in subdivision 3.3.

In the facets of methodological analysis, the first measure is look intoing stationarity of the series by Unit Root Tests, which includes augmented Dickey-Fuller trial and Phillips-Perron trial for look intoing the stationarity of the four series, 2nd measure is the application of cointegration analysis by using Johansen-Juselius process that statistically reveals the Numberss of the long-term relationship among the series, and the 3rd and besides the last measure is causality analysis, where vector mistake rectification theoretical account is estimated if possible to see the long tally relationship among the series. On the other manus, if the mentioned series are non cointegrated, vector autoregression theoretical account is so been estimated to see the short tally kineticss among the series. In add-on, Granger causality trial is conducted to separate the way of the short-term causality, from one-sided, bilateral, or none among the four series.

## 3.1 Empirical Model

The dependent variable or series in this survey is the trade balance in United States ( U.S. ), while the existent national income, domestic money supply and the existent exchange rates of U.S. are independent variables and the theoretical determiners of trade balance ( Wang, 2007 ; Ng et al., 2008 ; Craig, 1981 ). In order to analyse the relationship between U.S. trade balance and its determiners, the undermentioned theoretical account can be used as similar to what Duasa ( 2007 ) and Waliullah et Al. ( 2010 ) have done in their research on trade balance ‘s determiners:

( E 3.1 )

where i??i is the coefficients, LTBt, LRGDPt, LRM2t, and LRERt are natural logarithm series that represent U.S. trade balance, existent national income, existent domestic money supply, and existent exchange rate severally. The expected mark for i??1, which is the slope coefficient of existent national income, could either be positive or negative undermentioned classical theory. If will be positive if the addition in existent national income tends to increase the production of import-substituted goods instead than flows to import ( Ng et al., 2008 ). The expected mark for i??2 and i??3, in contrast, should be negative to bespeak the negative relationship between money supply and trade balance ( Craig, 1981 ) every bit good as the negative relationship between existent exchange rate and trade balance ( Falk, 2008 ; Chiu et al., 2010 ).

The net export ratio ( TB = export value / import value ) has been widely accepted for bespeaking trade balance in many empirical surveies, including Bahmani-Oskooee ( 1991 ), Bahmani-Oskooee and Brooks ( 1999 ), Onafowora ( 2003 ), Duasa ( 2007 ), Ng et Al. ( 2008 ) and Waliullah et Al. ( 2010 ). This ratio is preferred because it removes the demand for appropriate monetary value index to explicate the trade balance in existent term and it is non sensitive to the unit of measurement Bahmani-Oskooee ( 1991 ). The index used for exchange rate is existent exchange rate index[ 1 ]( RER ). RGDP and RM2 are denominated in one million millions of US $ and used for stand foring existent national income and existent money supply. All series are expressed in term of natural logarithms signifier in this survey in order to do comparable rating of analytic relationships among the series despite series arising from unequal values.

## 3.2 Data Analysis

Data wise, all of the secondary informations are one-fourth from 1st one-fourth of 1980 to 1st one-fourth of 2012, which sum of 129 observations. This sample size is sufficiently fulfilling the minimal demand for empirical trials, as the larger is the sample size, the better is the appraisal consequences ( Billingsley, 1995 ; Newey & A ; McFadden, 1994 ; Gujarati & A ; Porter, 2009 ). Additionally, big sample size can cut down the happening of job that caused by micronumerosity[ 2 ]( Goldberger, 1995 ; Gujarati & A ; Porter, 2009 ). The information beginnings include U.S. Bureau of Economic Analysis for TB and RGDP and the Conference Board, Inc. for RM2. As for RER, The informations beginnings for its elements include U.S. Bureau of Labor Statistics for CPI of U.S., Statistics of Canada for Canadian CPI and Federal Reserve Bank of New York for the nominal exchange rate.

Furthermore, the get downing one-fourth of 1980 is selected because there was a important structural alteration that caused by forsaking of Bretton-Woods system and gilded criterion during 1970s, peculiarly, twelvemonth 1973. Thus the observation span of 1980 to 2012 can avoid the structural alteration.

## 3.3 Overview of Methodology

## 3.3.1 Unit Root Test

Dickey, Hasza, and Fuller ( 1984 ) stated that unit root trial can be used to look into the stationarity of a clip series procedure. The minutes of the distribution ( such as Mean, discrepancy and covariance ) of a stationary series[ 3 ]are clip independent as they do non alter over the clip period. The stationarity of the series ensures the theoretical account contain neither deterministic ( or linear ) nor stochastic ( or random ) tendency that make the series wander off from the average value, every bit good as free from job of heteroscedasticity and autocorrelation ( Enders, 2010 ).

On the other manus, a nonstationary series contains one or more clip dependent parametric quantities, particularly the mean and discrepancy. Hence it shows some clip tendency, either deterministic or stochastic, in the clip secret plan that hides the indispensable behaviour of itself. However, an appraisal utilizing two or more independently non-stationary series by usual manner like ordinary least-square ( OLS ) method may give specious consequence. Specious arrested development makes the appraisal undependable, as it tells that there is important relationship ( s ) among the independent clip series that are purportedly non related to each other ( Granger & A ; Newbold, 1974 ).

Therefore, the checking of stationarity of the tried series is imperative and it must be completed beforehand because of the fact that many macroeconomic variables are non-stationary and most of them are integrated of order ( 1 ). This phenomenon has been through empirical observation proven by research workers like Nelson and Plosser ( 1982 ). Additionally, Stock and Watson ( 1989 ) argued that the causality trials are really sensitive toward the stationarity of the series.

As what have been done by Baharumshah ( 2001 ), this paper utilizes two unit root trial: augmented Dickey-Fuller ( ADF ) trial and Phillips-Perron ( PP ) trial for look intoing the stationarity of series and the consistence of consequences from the two unit root trials.

## 3.3.1.1 Augmented Dickey-Fuller ( ADF ) Trial

Similar to the original Dickey-Fuller ( DF ) trial ( 1979 ), if the coefficient of lagged dependant variable ( i?§ ) is equal to zero or higher than zero, so series Yt is considered as incorporating a unit root, or Yt is non-stationary. Table 3.1 shows the three different sets of theoretical account that allow different premises of the exogenic variables made on the series. For illustration there is a changeless impetus or intercept lied in Yt, so model 2 that includes an intercept term should be used for the trial.

Table 3.1 General Models of augmented Dickey-Fuller Test.

Premise of Exogenous

Model

( 1 ) None

( 2 ) Intercept

( 3 ) Intercept and Linear Trend

Dickey and Fuller ( 1981 ) have suggested an augmented version of DF trial that includes an excess lagged term of the dependant variable in order to turn to the issue that the tried series might hold a higher order of autocorrelation than one. The chief ground for this extension is that the hapless public presentation of original DF trial to separate between non-stationary procedures and extremely autocorrelated stationary procedures ( Enders, 2010 ). Often, there are two ways to find the slowdown length on these excess footings, such as utilizing the frequence of the informations, or by utilizing the information standards through the minimal Akaike Information Criterion ( AIC ) or minimal Schwartz Information Criterion ( SIC ). In this paper, SIC is selected because it is more consistent and it improves in public presentation with big sample size as in contrast of AIC ( Acquah, 2010 ; Bickel & A ; Zhang, 1992 ; Zhang, 1993 ). The proving hypotheses under ADF trial are:

H0: Series is nonstationary ( i?§iˆ iˆ?iˆ iˆ° ).

H1: Series is stationary ( i?§iˆ iˆ?iˆ iˆ° ).

Noted that under the void hypothesis of nonstationary, the statistic does non follow the conventional t-distribution, Dickey and Fuller ( 1979 ) derived asymptotic critical values for this issues, and MacKinnon ( 1991, 1996 ) implements a much larger set of simulations subsequently. The void hypothesis can be rejected if the tau ( i?? ) -statistic is lesser than the critical value, which depend on the premise of changeless impetus and additive tendency, otherwise it is non rejected.

## 3.3.1.2 Phillips-Perron ( PP ) Trial

( E 3.2 )

Phillips and Perron ( 1988 ) have developed an alternate unit root trial that besides addresses the hapless public presentation of Dickey-Fuller trial. Unlike ADF trial, PP trial corrects for any consecutive correlativity and heteroscedasticity in the mistake footings ut non-parametrically by modifying the Dickey Fuller t-test statistics with the utilizing of Newey-West ( 1987 ) heteroscedasticity- and autocorrelation-consistent covariance matrix calculator. Therefore PP trial is robust with regard to unknown autocorrelation and heteroscedasticity in the mistake footings of the trial theoretical account. The hypotheses proving of PP trial are:

H0: Series is nonstationary.

H1: Series is stationary.

The void hypothesis can be rejected if the tau ( i??iˆ©-statistic is lesser than the critical value, otherwise it is non rejected.

## 3.3.2 Testing for Cointegration

( E 3.3 )

Harmonizing to Brooks ( 2008 ), if two or more series are independently integrated at a equivalent higher order[ 4 ], says first order, I ( 1 ), and if they are sharing a common stationary series which integrated at degree, I ( 0 ), so certain cointegrating relationship is expected to be existed among these series. While cointegrating relationship means certain long-term accommodation mechanisms that maintain the equilibrium balance among the series.

Take the theoretical account above as illustration, the consequence of regressing the two I ( 1 ) series, Yt and Xt, is easy going specious, but if the residuary term, et, is I ( 0 ), so there likely are certain cointegration between Yt and Xt and the consequence is non considered specious any longer. If the cointegrating relationship ( s ) is proven, so vector mistake rectification theoretical account ( VECM ) can be estimated to mensurate the cointegrating or long-term relationships between Yt and Xt. However, if the residuary term is non I ( 0 ) but instead I ( 1 ), so the a-theoretical vector autoregression ( VAR ) theoretical account is estimated because there is no cointegrating relationship between Yt and Xt.

## 3.3.2.1 Johansen-Juselius ( JJ ) Multivariate Cointegration Procedure

Alternatively of utilizing the Engle-Granger ( 1987 ) two-step process, the Johansen and Juselius ( 1990, 1993 ) multivariate cointegration trial is preferred in this survey to prove the presence of cointegrating relationship due to JJ trial has several advantages over Engle-Granger attack. First, JJ trial can follow multiple cointegrations in the system in instance there are more than two variables in the system. Second, it treats all variables endogenously so it avoids the job of exogeneity and does non necessitate any arbitrary standardization. Third, JJ model is chiseled that it enables the theoretical account to spot the long tally every bit good as short tally causality among variables within the VECM. Last, JJ process allows for proper proving on the cointegration vector by utilizing maximal likeliness calculators, every bit good as for proving certain limitations on the estimated variables by the economic theory of the estimations.

Apart from that, Phillips ( 1991 ) has documented the desirableness of the JJ process in footings of symmetricalness, unbiasedness and efficiency. This process besides does non endure from job when conditional heteroscedasticity is present ( Lee & A ; Tse, 1996 ). The JJ methodological analysis is based on the undermentioned unrestricted VAR theoretical account:

( E 3.4 )

where Yt is a ( thousand x 1 ) vector of variables, degree Celsius is a ( thousand x 1 ) vector of changeless footings, i?‡i are ( thousand x m ) coefficient matrices and Iµt is a ( thousand x 1 ) vector of serially uncorrelated mistake footings with nothing mean and changeless discrepancy. However, economic clip series are largely non-stationary and therefore the VAR model is normally been restructured in first difference signifier as:

( E 3.5 )

Now this VAR theoretical account is in the usual first difference signifier except the term i??Yt-p. The rank of the iˆ matrix i?? is the chief intent of carry oning the JJ trial in this survey as it determines the Numberss of cointegration among the series in the system, which besides can be denoted by R or cointegrating vector. There are three possible results from the trial:

If rank ( i?? ) is equal to zero ( r = 0 ), so i?„Yt depends merely on i?„Yt – I but non on Yt – p. This indicates there is no long tally relationship between the elements of Yt, hence there is no cointegration and the theoretical account is a VAR with first differencing order.

If rank ( i?? ) is equal to m or it is at full rank ( R = m ), so it indicates a convergent system of the elements of Yt, so they are all stationary.

If rank ( i?? ) is greater than zero and carry throughing the status of 0 & lt ; R & lt ; m, so it indicates that there has R figure of long tally relationship occurred among the series. This status is a requirement of treating to VECM mold.

There are two test statistics have been suggested to through empirical observation analyze the figure of cointegrating vectors, maximal statistic and trace statistic:

( E 3.5 )

( E 3.6 )

where I are the characteristic root of a square matrixs and T is the figure of observation.

The hypotheses proving for JJ trial are:

## Null hypothesis

## Maximum alternate

## Trace option

H0: cointegrating rank is equal to zero ( r = 0 ).

H1: cointegrating rank is equal to one ( r = 1 ).

H1: cointegrating rank is greater than zero ( R & gt ; 0 ).

H0: cointegrating rank is equal to one ( r = 1 ).

H1: cointegrating rank is equal to one ( r = 2 ).

H1: cointegrating rank is greater than one ( R & gt ; 1 ).

H0: cointegrating rank is equal to m – 1 ( R = m – 1 ).

H1: cointegrating rank is equal to m ( r = m ).

H1: cointegrating rank is equal to m ( r = m ).

For both max trial ( i?¬max ) and trace trial ( i?¬trace ), the void hypothesis can be rejected if the eigen-value ( i?¬i ) is greater than the critical value. In order to observe the right order of cointegration vector, the rank is kept on tested by increasing the order until the void hypothesis is non rejected.

## 3.3.3 Causality analysis

## 3.3.3.1 Vector Autoregression ( VAR )

A vector autoregression ( VAR ) is concerned with the short tally kineticss between the independent series with a same order of integrating ( Garratt, Lee, Pesaran & A ; Shin, 1999 ). Those series can be degrees if all the series is I ( 0 ), or in differences if all the series are I ( vitamin D ), 500 & gt ; 0, and non cointegrated. Hence if a set of series is proven non cointegrated, so VAR can be applied to turn to the additive mutualities among the series in either flat signifier or difference signifier. However, as most of the economic series are non-stationary and integrated of order one, therefore for a set of I ( 1 ) endogenous variables that are non integrated ( r = 0 ), a first difference VAR ( P ) with P slowdown order can be estimated as:

( E 3.7 )

where i?„ is first difference operator, degree Celsius is a ( mA A-A 1 ) vector of intercept footings, i?‘i is a ( mA A-A m ) matrix of coefficients and i?µt are serially uncorrelated mistake footings with nothing mean and changeless discrepancy.

A feature of VAR is that it treats all variables symmetrically, which it does non separate the variables sing on their dependence or independence ( Enders, 2010 ). This a-theoretical characteristic allows 1s to carry on VAR patterning without adept cognition about the variables, so research workers can hold a proficient easiness in analyzing relationship among a set of economic series by utilizing VAR. However, this characteristic besides been criticized as the estimated consequences are merely numerically based that carries really small economic contents.

## 3.3.3.2 Vector Error Correction Model ( VECM )

A vector mistake rectification theoretical account ( VECM ) is concerned with the goings from the long-term cointegrating relationship between the degrees of those I ( 1 ) series, every bit good as short-term causalities between the differences in the series ( Pesaran, Shin, & A ; Smith, 2000 ). Engle and Granger ( 1987 ) province in the Granger-Engle representation theorem that any cointegrating relationship can be expressed by an equilibrium rectification theoretical account or mistake rectification theoretical account ( ECM ). Therefore, following the Granger-Engle representation theorem, an ECM consists of the alterations in the dependant variable and a coefficient of the mistake rectification term ( ECT ). While the alterations in the dependant variable represent a map of the short tally divergence from the cointegrating relationship and alterations in other variables, coefficient of the ECT indicates the velocity of accommodation that adjusts the divergence back to the long tally equilibrium, if any. As aforesaid, if the rank ( i??iˆ© = R, is carry throughing: 0 & lt ; R & lt ; m, so the VECM can be estimated and presented as:

( E 3.8 )

where degree Celsius is a ( mA A-A 1 ) vector of intercept footings, i??ECMt-p is the mistake rectification theoretical account, i?? is the matrix of long-term accommodation factor, i?‡i is the coefficient matrix, and P is the optimum slowdown length that the mistake footings i??t is serially uncorrelated with nothing mean and changeless discrepancy.

The entreaty of ECM model is its capableness of capturing both the short tally causalities and long tally relationships lied within the series whilst integrating the equilibrium suggested by economic priori at the same clip ( Hendry & A ; Richard, 1983 ). Dolado, Jenkinson and Sosvilla-Rivero ( 1990 ) further back up the position with remark that ECM preparation combines flexibleness in dynamic specification with desirable long-term belongingss.

## 3.3.3.3 Granger Causality trial

For either models of VECM or VAR, Granger causality ( 1969 ) trial can be applied to find the possible being of every bit good as the way of short tally causalities between the series system. Granger ( 1969, 1986 ) attack to the inquiry of whether the slowdown of one series explains the current value of one another, for case, how can a series Yt be explained by its ain lagged values and adding the lagged values of another series Xt. Thus, Granger causality determines whether one clip series is utile in calculating one another by bettering the account. If Crosstalk does better the account of Yt, so Xt is Granger caused Yt.

Given the instance of Xt and Yt, there are four possible results that needed to be distinguished:

Unidirectional causality from Xt to Yt,

Unidirectional causality from Yt to Xt,

Feedback, or bilateral causality between Xt and Yt, or

No causality between Xt and Yt.

As Granger representation theorem suggests if the series are cointegrated so there must be at least one causal relationship among them running in one way, Sims, Stock, and Watson ( 1990 ) and subsequently Toda and Phillips ( 1993 ) show that when the series are cointegrated of order 1, VEC Granger causality Wald trial can be used based on the mistake rectification theoretical account to find the short tally causality within the series system.

Take the same theoretical account as E 3.8 as illustration, the Granger causality Wald trial restricts the matrices of coefficient, i?‡i, equal to zero for each equation in the system ( e.g. for equation of i?„LTB as the dependent series and so on ). Therefore, if the coefficients of lagged independent series are non significantly different from nothing, so there is no Granger causality between the independent series and the dependent series. The hypotheses of the VEC Granger causality trial are:

H0: The excluded variable does non Granger do the dependant variable

H1: The excluded variable Granger causes the dependent variable

The void hypothesis can be rejected if the trial statistic is greater than the chi-square ( ) critical value, otherwise it is non rejected.

## 3.4 Decision

As decision, we use the cointegration attack to analyse the long tally relationships between the U.S. trade balance and its determiners such as existent national income, local money supply and existent exchange rate. The four variables are proxy as LTB, LRGDP, LRM2, and LRER severally. The survey is run with 129 observations from each of the four clip series informations. The methodological analysis consists chiefly of three parts. The first portion examines the stationarity of all the four series, the 2nd portion is the Johansen-Juselius model that analyze the possible long tally cointegrations among the series, and the last subdivision is the causality analysis which bases on either vector mistake rectification model or vector autoregression model. In add-on to that, Granger causality trial is conducted to find the short tally causality among the four series.

## Chapter 4: Consequence AND Interpretation

## 4.0 Introduction

The empirical consequences of the methods introduced in the old chapter will be reported and interpreted in this chapter. Section 4.1 shows the consequences of unit root trials with use of augmented Dickey-Fuller trial and Phillip-Perron trial, subdivision 4.2 provides the consequence of Johansen-Juselius multivariate cointegration trial, and subdivision 4.3 discusses the consequences of causality analysis under vector mistake rectification model.

## 4.1 Unit root trials

As a preliminary measure, unit root trials are conducted for each single series to supply an overview of the clip series belongingss of each series. Table 4.1 summarizes the consequence of utilised augmented Dickey-Fuller ( ADF ) trial and Phillips-Perron ( PP ) trial on level-series, with premises of changeless impetus every bit good as changeless impetus with additive tendency.

Table 4.1: Consequence of ADF trial and PP trial ( Series in degrees )

Series ( Level )

Intercept

Intercept with Trend

ADF

PP

ADF

PP

LTB

-2.6378*

-1.8803

-2.3181

-1.7199

LRGDP

-1.2528

-1.1920

-1.2484

-0.8158

LRM2

0.6209

0.9051

-0.8740

-0.8651

LRER

-1.3189

-1.4526

-1.2765

-1.3626

Notes: *, **, *** represents rejection of void hypothesis at 10 %, 5 % and 1 % degree of significance severally. The figures are tau ( i?? ) – statistics. All rejection is based on the critical values proposed by MacKinnon ( 1996 ). The minimal slowdown length choices for ADF trial are based on SIC. The bandwidth choices for PP trial are based on Newey-West. The spectral appraisal method used in PP trial is Bartlett kernel method.

The consequence indicates that the tau ( i?? ) -statistic of all series is statistically undistinguished at the conventional degrees of significance, therefore all of them is nonstationary in degrees for both sets of premise. The lone exclusion is that LTB is stationary under ADF trial consequence with the premise of intercept, because the i??-statistic of -2.6378 is important at 10 % degree of significance, therefore the void hypothesis can non be rejected in this instance. This is the lone confliction between the consequences of ADF trial and PP trial. However, as harmonizing to Cheung and Lai ( 1997 ), PP trial outperforms ADF trial with the betterment due to the combined usage of prewhitening process and experimental bandwidth choice. Therefore, we conclude that all series is nonstationary in degree under both sets of exogenic premise. This consequence leads us to foster the unit root trial until we find out the appropriate integration order for each series. Table 4.2 summarizes the consequence of ADF trial and PP trial on the first-differences of each series, with premises of changeless impetus every bit good as changeless impetus with additive tendency.

Table 4.2: Consequence of ADF trial and PP trial ( Series in first difference )

Series ( First difference )

Intercept

Intercept with Trend

ADF

PP

ADF

PP

i?„LTB

-7.2474***

-9.8147***

-9.2816***

-9.7462***

i?„LRGDP

-5.4488***

-7.9174***

-5.7072***

-8.0690***

i?„LRM2

-6.8132***

-6.8132***

-6.8619***

-6.8619***

i?„LRER

-10.116***

-10.084***

-10.109***

-10.075***

Notes: *, **, *** represents rejection of void hypothesis at 10 %, 5 % and 1 % degree of significance severally. The figures are tau ( i?? ) – statistics. The critical values are computed utilizing MacKinnon ( 1996 ) p-values. The minimal slowdown length choices for ADF trial are based on SIC. The bandwidth choices for PP trial are based on Newey-West. The spectral appraisal method used in PP trial is Bartlett kernel method.

The consequence shows consistent end products for both ADF trial and PP trial that all of the i??-statistics is important at even 1 % degree of significance, bespeaking that all of the series achieves stationary after first-differencing. In other words, the four series are integrated at a same order, one, so they can be denoted as I ( 1 ) series in our survey. This determination suggests that ordinary least-square ( OLS ) appraisal method is non suited in this survey, and hence cointegration trial is necessary to look into whether there are steady province equilibrium relationships among these I ( 1 ) series ( Engle & A ; Granger, 1987 ).

## 4.2 Johansen-Juselius ( JJ ) Cointegration trial

Knowing that the series are integrated of the same order I ( 1 ), Johansen-Juselius ( JJ ) multivariate cointegration trial is employed to look into the possible long run cointegration among the series. Given that the choice of slowdown length is important for carry oning JJ trial, the optimum slowdown length is chosen based on the Ljung-Box ( 1978 ) Q-statistics. Lag length of two is selected which the mistake footings in each equation in the system do non exhibit any signifier of consecutive correlativity at 1 % degree of significance. Table 4.3 summarizes the consequence of JJ cointegration trial for both hint statistic ( i?¬trace ) and max statistic ( i?¬max ) in panel Angstrom, every bit good as the cointegration equation in panel B.

Table 4.3: Consequence of JJ Multivariate Cointegration Test

Panel A: Multivariate JJ Test

Null Hypothesis

i?¬trace

i?¬max

Critical Value ( 5 % )

Trace

Soap

R = 0

52.4174**

A 29.6831**

A 47.8561

A 27.5843

R a‰¤ 1

22.7343

A 19.4800

A 29.7971

A 21.1316

R a‰¤ 2

3.25432

A 2.13729

A 15.4947

A 14.2646

R a‰¤ 3

1.11703

A 1.11703

A 3.8415

A 3.8415

Panel B: Normalized Cointegrating Vector

LTB

LRGDP

LRM2

LRER

Changeless

1.0000

0.8032

-0.8195

-1.0914

-0.2836

t-statistic =

[ -2.3673 ] **

[ 2.1866 ] **

[ 4.0944 ] ***

Notes: *, **, *** denotes rejection of void hypothesis at 10 %, 5 % and 1 % degree of significance. i?¬ represents the statistic in footings of likeliness ratio. Ljung-Box Q-statistic is utilised to choose the minimal slowdown length of two ( one-fourth ). The cointegration is estimated with premise of changeless intercept but without additive tendency. The critical values are computed utilizing MacKinnon-Haug-Michelis ( 1999 ) p-values.

In panel Angstrom, both trace statistic and max-eigen statistic study that the void hypothesis of no cointegration is rejected at 5 % degree of significance with i?¬trace of 52.4174 and i?¬max of 29.6831. Yet the void hypothesis of at least one cointegration is non rejected at all conventional degrees of significance with i?¬trace of 22.7343 and i?¬max of 19.4800. This concludes that there is one cointegrating relationship occurs among the I ( 1 ) series – trade balance of U.S. and its determiners – and it is captured by the cointegrating vectors reported in panel B.

Based on the consequence obtained in panel B, the existent national income ( LRGDP ) is positively act uponing the trade balance ( LTB ) in U.S. with the estimated coefficient of 0.8032. Furthermore, the t-statistic of -2.3673 shows that LTB is significantly impacted by LRGDP at 5 % degree of significance. This estimated relationship is consistent with the findings of Waliullah et Al. ( 2010 ).

At the same clip, the estimated coefficient of -0.8195 and the t-statistic of 2.1866 suggests that there is a important and negative relationship between existent money supply ( LRM2 ) and U.S. trade balance, which is consistent with the findings of Duasa, ( 2007 ) and Waliullah et Al. ( 2010 ) and the pecuniary theory of trade balance. All else being equal, pecuniary theory emphasiss that if the domestic supply of money is greater than the domestic demand for money, the extra retention of money will so increase the outgo, imports additions in bend to fulfill the increased local demand for goods, and finally causes a trade shortage ( Craig, 1981 ; Melvin, 2003 ).

Similarly, the estimated coefficient of -1.0914 shows a negative relationship established between existent exchange rate ( LRER ) and trade balance, proposing that the Marshall Lerner status is keeping in the long tally economic system of United States. Marshall Lerner status provinces that a depreciation of exchange rate that leads to currency devaluation that will hold positive impact on trade balance in long tally, where the export or foreign demand for domestic goods additions due to take down monetary value degrees of the exporting goods ( Blanchard, 2011 ; Davidson, 2009 ). In footings of the significance, the t-statistic of 4.0944 clearly provinces that LTB falls significantly to the alterations of LRER at 1 % degree of significance. ( Bhattarai, 2005 ; Matesanz et al., 2009 )

Since the consequence of cointegration rank fulfills the status of 0 & lt ; R & lt ; m ( 0 & lt ; 1 & lt ; 4 ). Henceforth, alternatively of utilizing vector autoregression ( VAR ), we proceed to the mold of vector mistake rectification theoretical account ( VECM ) to analyse both long tally and short run relationships among the series.

## 4.3 Causality analysis based on VECM Framework

Provided the being of one cointegrating vector among the I ( 1 ) series like what is shown in panel B of Table 4.3, we estimate the vector mistake rectification theoretical account ( VECM ) to turn to both long tally and short tally kineticss between the trade balance and its determiners such as existent national income, money supply, and existent exchange rate. In line with the Johansen-Juselius process, lag length two is selected which the mistake footings in each equation in the system do non exhibit any signifier of consecutive correlativity at 1 % degree of significance based on Ljung-Box Q-statistic.

Table 4.4 summarizes temporal causality consequences based on vector error-correction theoretical account. In facets of long tally relationship, we check whether the cointegrating equation or mistake rectification theoretical account ( E 4.1 ) is important in long tally equilibrium accommodation. While for the portion of short tally kineticss, we adopted the VEC Granger Causality trial to find the short tally causal relationship among the variables.

Table 4.4 Result of VEC Granger Causality Test

Short tally lagged differences

Coefficient of ECT

Dep. Var.

chi-square ( ©iˆ statistic

t-statistic

## –

11.5362***

6.70749**

0.81695

-0.0743***

3.00292

## –

3.96574

4.08695

0.0093*

10.1573***

9.55416***

## –

1.88532

-0.0098

2.90489

0.53249

26.5135***

## –

-0.0022

Note: *, **, *** denotes rejection of void hypothesis at 10 %, 5 % and 1 % degree of significance. i?„ is the first difference operator. Ljung-Box Q-statistic is utilised to choose the minimal slowdown length of two ( one-fourth ) for the VECM arrested development.

A chief characteristic of cointegrating equation or mistake rectification theoretical account ( ECM ) is that the clip waies of the cointegrated variables are influenced by the magnitude of any daze from long-term equilibrium. The last column in Table 4.5 tells the coefficients of mistake rectification term for each equation. As celebrated, the negative and important ECM in the equation of differenced trade balance ( i?„LTB ) and differenced existent national income ( i?„LRM2 ) indicates that there are long tally accommodations borne by trade balance and existent national income if any disequilibrium daze in the included series is presence. In other words, any divergence from the long tally balance is corrected back to the initial equilibrium of trade balance and existent national income by the cointegrating mechanism or the mistake rectification theoretical account. The velocity of upward accommodation for trade balance is 7.43 % per short tally period ( one-fourth ), while for existent national income, it will be adjusted upwards besides at a rate of 0.93 % per period.

It is apparently that there is no important long tally accommodation exists in existent money supply ( i?„LRM2 ) and existent exchange rate ( i?„LRER ) even at 10 % degree of significance, proposing that any daze deviates off the long tally balance of LRM2 and LRER will non efficaciously be adjusted back to the initial equilibrium but it will instead roll up over clip.

In facets of short tally kineticss that reflect by Granger causalities, the first row shows that the statistics of 11.5362 for with mention to represents that lagged coefficients of in the arrested development equation of are significantly different from zero, intending that Granger causes at 1 % degree of significance. Similarly, the statistics of 6.70749 for in the arrested development equation of indicate the rejection of void hypothesis at 5 % degree of significance, so is Granger causal for besides. However, the void hypothesis can non be rejected for single lagged coefficients of with regard to the trial consequences for equation since the statistics of 0.81695 is non important, this suggests that is non influenced by. In short, and are Granger Causal for at 1 % and 5 % degree of significance, while does non Granger do at all conventional degree of significance.

Meanwhile in the equation of, is Granger caused by the person lagged coefficients of the and but non. and Granger cause at 1 % degree of significance with statistics of 10.1573 and 9.55416 severally, but is non Granger causes at with statistics of 1.88532. This concludes that and are short tally causal for.

For the equation of, there is merely one rejection of void hypothesis which Granger causes at 1 % degree of significance with statistics of 26.5135, but the remainder of the series is failed to reject the void hypothesis even at 10 % degree of significance. This indicates that merely has short run kineticss toward among the three series.

Slightly similar to the instance of, there is no rejection of void hypothesis in the equation of. All the lagged coefficients of, and is non significantly different from zero, therefore the three variables are non Granger causal for. Therefore, there is no short tally dynamic from any of the three series to.