Real Exchange Rate Volatility on the Short- and Long-Run Trade Dynamics in Colombia

Abstract

The short- and long-run implications of real exchange rate volatility on Colombian bilateral trade commodities and non-commodities with its major trade partners are analyzed from the perspectives of the Marshall-Lerner condition, a cointegration relation with other aggregate variables, and the J-curve hypothesis. Long-run equilibrium on the Colombian bilateral balance of trade with a country is more common when the trade volume is denominated in terms of one of the world's main currencies—as is the case of commodity trade and trade with a country whose national currency is one of these currencies. No evidence of the J-curve was found in any of the analyzed Colombian bilateral balances of trade. Opposite to the predictions of the J-curve hypothesis, more common are the scenarios of short-run improvements in the bilateral trade balances following a devaluation than are those with instantaneous declines. Improvements in the terms of trade are found to have a long-run deteriorating impact on the Colombian balance of trade, especially in the case of non-commodity trade. Policy makers should consider that continuous improvements in the Colombian terms of trade, as the ones recently observed, will ultimately be a detriment to the country's current balance of trade surplus.

Keywords:

• bilateral balance of trade
• real exchange rate fluctuations
• Colombia
• commodities
• non-commodities

Notes

¹Colombia's main international trade partners are Germany, Belgium, Brazil, China, Ecuador, the U.S., Netherlands, Italy, Japan, Mexico, Panama, Peru, the U.K., Dominican Republic, Switzerland, and Venezuela. Sources and descriptions of the data are provided in Section 3 of the article.

FIGURE 1 Colombian real exchange rate index (right axis) and net exports of all goods, commodities, and non-commodities (left axis) with its main trade partners for the 1998–2011 period (color figure available online). Source: Central Bank of Colombia.

²The Real Exchange Rate Index published by the Banco de la República of Colombia is used (1994 = 100). An increase in the Index indicates a real devaluation of the Colombian peso. A detailed explanation of the methodology used to construct the Index can be found in Huertas (2003).

³The data sources from which the growth rates were calculated are the All Commodity Price Index and Crude Oil Price Index, available at the data appendix of Beidas-Strom et al. (2012).

⁴LAC-7 members are Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela.

⁵According to the Openness Index, the yearly openness growth rate of Colombia for the 1998–2009 time period was 2.1%, for Brazil 3.3%, and for Mexico 3.8%. Source: Heston et al. (2012), Penn World Table Version 7.1.

⁶Appendix A provides a detailed description of those goods considered in the study as commodities with their respective HS Code Classifications.

⁷Annual average values, in millions of nominal USD, on the Colombian bilateral trade of non-commodities, by major types of goods and services, are presented in Appendix B.