Investigating the Nonlinear Effect of Real Exchange Rate on Iran's Balance of Trade: Smooth Transition Regression Approach

Traditional theories of international economics insist on the devaluation of the national currency as an effective policy to curb current account deficits. The recent literature, while stressing the vague effect of the devaluation of the national currency on the trade balance, emphasizes on the asymmetric response of commercial variables to exchange rate changes. This study aims to investigate the nonlinear relationship between the real exchange rate and trade balance, using a smooth transition regression approach during period 1981-2014. The results of the model estimation, while confirming the nonlinear effect of real exchange rate on the trade balance, indicate that the effect of the real exchange rate variables, the degree of trade openness and the GDP growth rate on the trade balance depending on the regime in which the economy is operating.The results also show that in general the sum of real exchange rate coefficients in the first regime has a positive effect and in the second regime has a negative effect on the balance of trade. Also, the sum of coefficients of GDP growth rate in the first and second regimes have a negative effect on the trade balance.On the other hand, the sum of coefficients of trade openness in the first regime have a negative effect and in the second regime have a positive effect on business balance.