Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia , ISBN: 978-1-922069-64-1
1
2
This paper investigates the response of the exchange rate and the trade balance to monetary Policy innovations for the Selected Countries such as Kazakhstan, Russia, Australia and South Korea during the period 1995:Q1-2012:Q1. This countries follow inflation targeting as a policy and in recent papers like
Mishkin(2008) , Gertler(2005) find that inflation targeting has been a highly successful monetary policy strategy for many emerging market countries and has led to greater improvement performance for advanced- country inflation targets.
The empirical findings indicate that contractionary monetary policy shocks lead to transitory appreciations of the real and the nominal exchange rate. Exchange rate appreciations that are related to a temporary contractionary shock to monetary policy lead to a short-lived improvement in the trade balance which is then followed by deterioration, giving support to the J-curve hypothesis.
Key word: Monetary Shock – Trade Balance – J-Curve – Inflation targeting countries
JEL Code: F32, F41, F6
In this paper we address a controversial question in open economy macroeconomics:How do the exchange rate and the trade balance respond to monetary policy innovations?According to exchange rate overshooting models, a contractionary monetary policy shockcauses a large initial appreciation followed by depreciation in nominal and real exchange rates.This view is not supported by the findings of Eichenbaum and Evans (1995) who find that acontractionary shock to U.S. monetary policy leads to persistent appreciations in nominal andreal U.S. exchange rates.
Another point of controversy is related to the response of the trade balance to exchangerate movements. It is widely believed that a depreciation (appreciation) of the domesticcurrency against other currencies improves (deteriorates) the trade balance in the long-run, butworsens (improves) it in the short-run, generating a J-curve. A common explanation of the Jcurveis based on the assumption that export contracts are written in domestic currency unitsand import contracts are written in foreign currency units. Following a depreciation of thedomestic currency, prices of import goods rise in domestic currency units while prices of export goods do not change Therefore, the value of import goods rises significantly while little or nochange takes place in the value of exports. This causes the trade balance to deteriorate in theshort-run. Export and import quantities adjust over time to changes in relative prices. As thequantity of import goods falls in response to higher import prices and the quantity of exportgoods increases, the value of exports exceeds the value of imports, leading to an improvement inthe trade balance in the long-run.
Empirical evidence on the J-curve hypothesis is mixed. The majority of the literatureestimates "volume and pass through equations". Using this approach, Krugman and Baldwin(1987) find that the perverse effect
Dr. Abbas Aminifard , Department of Economics, Economics and Management College, Shiraz Branch, Islamic Azad University,
Shiraz, Iran,
1 aaminifard@yahoo.com
Sara Estedlal,
2
Sarah_estedlal@yahoo.com

Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia , ISBN: 978-1-922069-64-1 has duration of four quarters. The estimates of Artus(1975) and Helkie and Hooper (1987) imply J-curves lasting only one quarter. Moffett (1989),on the other hand, does not find any evidence for the J-curve. This result is also supported byRose and Yellen (1989) who estimate a "partial" reduced form equation for the net merchandisetrade balance.
On a theoretical note, Bacchetta and Gerlach (1994) show that J-curves can also arise ifimport prices adjust slowly to exchange rate changes. The intuition is that in an intertemporalframework, if import prices are sticky, consumers anticipate a rise in future import prices after adevaluation and therefore reallocate their purchases over time.
Intertemporal reallocation ofpurchases leads to the J-curve. This result implies that lack of evidence of "pass through" onimport prices does not necessarily mean that the J-curve does not exist.
In this paper we follow a more direct approach and investigate the response of the tradebalance to monetary innovations within the context of a vector autoregression (VAR) model,which is based on a simple open economy model. Analyzing the response of the trade balance toexchange rate movements within this context requires an understanding of how monetary policyaffects the economy. A broad class of open economy macroeconomic models including Calvo and Rodriguez (1977), Frenkel and Rodriguez (1982) and Ivrendi and Guloglu (2010) indicate that,following a permanent positive monetary policy shock, output and the price level increase, theinterest rate falls, the exchange rate depreciates, and the trade balance improves. Over time,however, output, the interest rate, the exchange rate, and the trade balance are expected toreturn to their initial values. The price level is expected to be permanently higher if themonetary policy shock is permanent. Recent evidence by Kim (2001), Mishkin (2007) andKemme and Sargsyan (2008)provide support for some of theresults predicted by these conventional models.
The methodology of the study is presented in section III of the paper, and the empiricalresults are presented and discussed in section IV. The results are summarized in the conclusion.
2. Description of Data
Data for this study are collected from three sources: the International Monetary Fund’s (IMF) direction of trade statistics (DOTS) for the bilateral import and export data; IMF’s International Financial Statistics (IFS) for the exchange rates data, consumer price index (CPI).Money volume (M, measured by M2 definition), the price level (P, measured by the personal consumption deflator), a nominal exchange rate measure (E), and a real trade balance measure (TB). The results reported below are essentially unchanged when the real exchange rate (RE) replaces the nominal exchange rate (E).
Our sample consists of quarterly data ranging from the 1995:Q1-2012:Q1. Finally, as necessary, data are adjusted to control for seasonal variation, transformed into log-form and expressed in 2000 as the base year.
3. Econometric Technique and Empirical Results
To investigate the response of the exchange rate and the trade balance to monetary policy innovations, VARs are employed.
This model provides "generic" estimates of the effects of monetary policy shocks on the variables of interest. The response exchange rate, and the trade balance to monetary policy shocks are analyzed by computing and plotting impulse response functions (IRFs).
Since the variables are integrated of order one, we proceed to test for co-integration. The co-integrationtest, formulized by Engle and Granger (1987), was further improved by Johansen (1988).As a preliminary procedure, it is also necessary to select the optimal model for the deterministiccomponents in the system. Therefore, following Johansen and Juselius (1992) we choose the model bytesting the joint hypothesis of both the rank order and the deterministic components, applying the socalledPantula’s (1989) principle. The results of the co-integration tests based on trace

Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia , ISBN: 978-1-922069-64-1 statistics suggest the choice of model 2 (with intercept (no trend) in cointegratingequation and no intercept in VAR) as the appropriate model. We found the existence ofoneco-integrating relations.
3.4. Impulse-Response Functions
The impulse response functions trace the effect of a one-standard-deviation shock in a variable oncurrent and future values of the variables. In our system, we use generalized impulse responsefunctions (GIRFs) proposed by Pesaran and Shin (1998), not those based on a Cholesky decompositionwhich is sensitive to the ordering of the variables.
Plotting generalized impulse response functions based on estimating vector error correction (VEC) model require three steps: identifying the existence of long-run relation among the variables in the model; selecting optimal lag for each specification; and, estimating the VEC model to generate the generalized impulse response function (Onfowora,
2003, p. 3). Since the bound F-testing procedure in the first step has already identified long-run relationship among the three variables in the model, our next step is to determine the optimal lag length, which we accomplish using the
AIC criterion. In the final step, the generalized impulse response functions of the trade balance to one standard deviation innovation (increase) in the real exchange rates are generated from the estimates of VEC model. The generalized impulse response functions are generated using the EVIEWS 6 software.
4-Emperical Results
In this part we show the result of Impulse – Response function for each country.
14- Russia
From 1991 until 2012, Russia Inflation Rate averaged 157.2 Percent reaching an all-time high of 2333.3 Percent in
December of 1992 and a record low of 3.6 Percent in April of 2012. In this period, Russian Ruble averaged 23.3 reaching an all-time high of 36.4 in February of 2009 and a record low of 1.0 in August of 1993. From 2000 until
2012, Russia Money Supply M2 averaged 9744.99 RUB Billion reaching an all-time high of 24739.20 RUB
Billion in October of 2012 and a record low of 1090.10 RUB Billion in January of 2001. Also from 1997 until
2012, Russia Balance of Trade averaged 8261.76 USD Million reaching an all-time high of 20647 USD Million in
December of 2011 and a record low of -185 USD Million in February of 1998. Metals and energy make up more than 80 percent of Russia's exports. The country is the world’s largest oil producer and the biggest exporter of natural gas, nickel and palladium. Russia imports mostly vehicles, machinery and equipment, plastics, medicines, iron and steel, consumer goods, meat, fruits and semi-finished metal products. Its main trading partners are:
European Union (Germany, Italy, France), China and Ukraine.
Plot 1 show Generalized Impulse – Response for Real Exchange rate , Money Supply and Balance of Trade

Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia , ISBN: 978-1-922069-64-1
Plot 1- (GIR) for Russia
Response of TB to TB
.20
.15
.10
.05
.00
-.05
1 2 3 4 5 6 7 8 9 10
Response of REXR to TB
3
2
1
0
-1
-2
1 2 3 4 5 6 7 8 9 10
Response of M to TB
1,200
800
400
0
-400
-800
1 2 3 4 5 6 7 8 9 10
24- Kazakhstan
.20
Response to Generalized One S.D. Innovations
Response of TB to REXR
.15
.10
.05
.00
-.05
1 2 3 4 5 6 7 8 9 10
Response of TB to M
.20
.15
.10
.05
.00
-.05
1 2 3 4 5 6 7 8 9 10
Response of REXR to REXR
3
2
1
0
-1
-2
1 2 3 4 5 6 7 8 9 10
Response of M to REXR
1,200
800
400
0
-400
-800
1 2 3 4 5 6 7 8 9 10
Response of REXR to M
3
2
1
0
-1
-2
1 2 3 4 5 6 7 8 9 10
Response of M to M
1,200
800
400
0
-400
-800
1 2 3 4 5 6 7 8 9 10
Historically, from 1999 until 2012, Kazakh Tenge averaged 134.1 reaching an all-time high of 155.5 in January of
2003 and a record low of 84.4 in January of 1999. In this period, Kazakhstan Inflation Rate averaged 83.8 Percent reaching an all-time high of 2960.8 Percent in December of 1992 and a record low of 1.9 Percent in December of
1998. According to Money Supply, M2 averaged 2076716.0 KZT Million reaching an all time high of 8761681.0
KZT Million in October of 2012 and a record low of 8197.0 KZT Million in December of 1993.
Historically, from 1998 until 2012, Kazakhstan Balance of Trade averaged 1308.39 USD Million reaching an all time high of 6852.80 USD Million in June of 2011 and a record low of -22.10 USD Million in November of 1998.
Exports of oil, gas and base metals (uranium, silver, zinc, nickel) account for more than 85% of Kazakhstan's exports and are key to the country economic success. Kazakhstan main exports market is European Union (more than 50% of total) with Italy, France and Netherlands being the most important. Others include China, Russia and
Switzerland. Kazakhstan imports mostly machinery and equipment, vehicles, metal products, foodstuffs and chemicals. Its main imports partners are: Russia, China, Ukraine, Germany, Italy and United States.

Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia , ISBN: 978-1-922069-64-1
Plot 2- (GIR) for Kazakhestan
Response of TB to TB
.1
.0
-.1
-.2
.4
.3
.2
1 2 3 4 5 6 7 8 9 10
Response of REXR to TB
4
2
0
-2
10
8
6
1 2 3 4 5 6 7 8 9 10
Response of M to TB
120,000
80,000
40,000
0
-40,000
-80,000
1 2 3 4 5 6 7 8 9 10
.1
.0
-.1
-.2
.3
.2
.4
Response to Generalized One S.D. Innovations
Response of TB to REXR
1 2 3 4 5 6 7 8 9 10
Response of REXR to REXR
4
2
0
-2
10
8
6
1 2 3 4 5 6 7 8 9 10
Response of M to REXR
120,000
80,000
40,000
0
-40,000
-80,000
1 2 3 4 5 6 7 8 9 10
Response of TB to M
.1
.0
-.1
-.2
.4
.3
.2
1 2 3 4 5 6 7 8 9 10
Response of REXR to M
4
2
0
-2
10
8
6
1 2 3 4 5 6 7 8 9 10
Response of M to M
120,000
80,000
40,000
0
-40,000
-80,000
1 2 3 4 5 6 7 8 9 10
34- Australia
Historically, from 1993 until 2012, the AUDUSD averaged 0.7500 reaching an all-time high of 1.1000 in July of 2011 and a record low of 0.4800 in April of 2001. From 1951 until 2012, Australia Inflation Rate averaged 5.3 Percent reaching an all-time high of 23.9 Percent in December of 1951 and a record low of -1.3 Percent in June of 1962.
In This period Money Supply M3 in Australia averaged 322214.65 AUD Million reaching an all-time high of 1496551
AUD Million in October of 2012 and a record low of 10191 AUD Million in March of 1965.
From 1971 until 2012, Australia Balance of Trade averaged -378.97 Million AUD reaching an all time high of 3478
Million AUD in June of 2010 and a record low of -3651 Million AUD in February of 2008. Rich in natural resources,
Australia is a major exporter of agricultural products, particularly wheat and wool, minerals such as iron-ore and gold, and energy in the form of liquefied natural gas and coal. Australia is a major importer of machinery and transport equipment, computers and office machines and telecommunication lasers. Its main trading partners are: Japan, China,
The United States and New Zealand.

Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia , ISBN: 978-1-922069-64-1
Plot 3- (GIR) for Australia
Response of TB to TB
4
3
2
1
0
-1
-2
1 2 3 4 5 6 7 8 9 10
Response of M to TB
30,000
20,000
10,000
0
-10,000
-20,000
1 2 3 4 5 6 7 8 9 10
3
2
1
0
-1
-2
4
Response to Generalized One S.D. Innovations
Response of TB to REXR
1 2 3 4 5 6 7 8 9 10
Response of M to REXR
30,000
20,000
10,000
0
-10,000
-20,000
1 2 3 4 5 6 7 8 9 10
Response of TB to M
4
3
2
1
0
-1
-2
1 2 3 4 5 6 7 8 9 10
Response of REXR to TB
100,000
50,000
0
-50,000
-100,000
-150,000
1 2 3 4 5 6 7 8 9 10
Response of REXR to REXR
100,000
50,000
0
-50,000
-100,000
-150,000
1 2 3 4 5 6 7 8 9 10
Response of REXR to M
100,000
50,000
0
-50,000
-100,000
-150,000
1 2 3 4 5 6 7 8 9 10
Response of M to M
30,000
20,000
10,000
0
-10,000
-20,000
1 2 3 4 5 6 7 8 9 10
44-South Korea
From 1981 until 2012, the USDKRW averaged 983.6400 reaching an all-time high of 1962.5000 in December of
1997 and a record low of 667.2000 in July of 1989. From 1966 until 2012, South Korea Inflation Rate averaged
8.10 Percent reaching an all-time high of 32.51 Percent in October of 1980 and a record low of 0.17 Percent in
February of 1999. Historically, from 1986 until 2012, South Korea Money Supply M3 averaged 924151.5 KRW
Billion reaching an all time high of 2409562.2 KRW Billion in September of 2012 and a record low of 57007.9
KRW Billion in January of 1986.
South Korea Balance of Trade averaged 420.30 USD Million reaching an all time high of 6794.27 USD Million in
June of 2010 and a record low of -4043.46 USD Million in January of 2008. South Korea relies largely upon exports to fuel the growth of its economy. The most important exports are finished products such electronics, semiconductors, LCD panel, mobile phone, computers related, television, motor vehicle, steel, ships and petrochemicals. South Korea imports machinery, oil, steel, transport equipment, organic chemicals and plastics. Its main trading partners are: China, European Union, The United States and Japan.

Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia , ISBN: 978-1-922069-64-1
Plot 4- (GIR) for South Korea
Response of TB to TB
.10
.08
.06
.04
.02
.00
-.02
1 2 3 4 5 6 7 8 9 10
Response of REXR to TB
.8
.6
.06
.04
.02
.00
-.02
.10
Response to Generalized One S.D. Innovations
Response of TB to REXR
.08
1 2 3 4 5 6 7 8 9 10
Response of REXR to REXR
.8
Response of TB to M
.10
.08
.06
.04
.02
.00
-.02
1 2 3 4 5 6 7 8 9 10
Response of REXR to M
.8
.6
.6
.4
.4
.4
.2
.0
1 2 3 4 5 6 7 8 9 10
Response of M to TB
30,000
20,000
10,000
0
-10,000
-20,000
1 2 3 4 5 6 7 8 9 10
.2
.0
1 2 3 4 5 6 7 8 9 10
Response of M to REXR
30,000
20,000
10,000
0
-10,000
-20,000
1 2 3 4 5 6 7 8 9 10
.2
.0
1 2 3 4 5 6 7 8 9 10
Response of M to M
30,000
20,000
10,000
0
-10,000
-20,000
1 2 3 4 5 6 7 8 9 10
5. Summary and Conclusion
The plots of the generalized impulse response functions are shown in Figure 1 to Figure 4. As illustrated in figure 1, no persistent J-curve like pattern can be observed in the time path of the trade balances to one standard innovation
(increase) in the real exchange rates. For example, after an initial overshooting through the first quarter, the Russia trade balance appears to deteriorate throughout the second, third and fourth quarters to shock in the real exchange rate.
Similarly, trade balances of the South Korea and Australia appear to deteriorate only through the first two quarters with no discernible persistent upward movement afterward. One common pattern that can be observed in all cases is that the time paths of trade balances seem to peter out over the twenty four quarters.
Our findings indicate that real exchange depreciation in Kazakhstan consists with J-curve Hypothesis but in Russia,
Australia and South Korea this hypothesis rejected.

Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia , ISBN: 978-1-922069-64-1
TABLE 1. Testing Long-Run Relationship Using Bound F-Test
Procedure
Country
South Korea
Australia
Kazakhstan
Russia
Sample Range F-values
1976q1-
2007q2
3.60
**
1976q1-
2007q2
4.71
*
1976q1-
2007q2
4.69
*
1976q1-
2007q2
11.49
*
Lags
5
4
2
2
*** inconclusive at 90% confidence level
** Significant at 90%, inconclusive at 95% confidence levels
* Significant at 95% confidence level
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Proceedings of 29th International Business Research Conference
24 - 25 November 2014, Novotel Hotel Sydney Central, Sydney, Australia , ISBN: 978-1-922069-64-1
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